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FRM Part II · FRM Exam Part II · Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques

A bank has a portfolio with a DV01 of $42,000 (loss per 1bp rise in yields). It hedges using futures on a bond with a DV01 per contract of $70 per bp. It also wants the hedge to be short futures. Later, a risk manager finds the portfolio's yield beta against the futures' yield is 1.2 (portfolio yield moves 1.2bp per 1bp move in the futures' yield). How many futures contracts should it short to hedge, using the beta-adjusted DV01 approach?

The bank should short 720 contracts. The raw DV01 hedge is 42,000 / 70 = 600 contracts, but because the portfolio yield moves 1.2 times the futures yield, the hedge must be scaled up by 1.2, giving 720 contracts.

  1. A720 contractsCorrect
  2. B600 contracts
  3. C500 contracts
  4. D840 contracts

Explanation

Unadjusted hedge = 42,000 / 70 = 600 contracts. Since the portfolio yield moves 1.2bp per 1bp in the futures yield, the portfolio loses 1.2 times as much relative to the hedge, so the hedge ratio is 600 x 1.2 = 720. Dividing by beta gives 500, the wrong direction. 840 would use 1.4 incorrectly.

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