Skip to content

FRM Part II · FRM Exam Part II · Regression Hedging and Principal Component Analysis

A bank holds USD 50 million face of a 10-year bond priced at par with a DV01 of 0.0800 per 100 of face value. It hedges with a 5-year bond priced at par with a DV01 of 0.0400 per 100 of face value, assuming equal yield changes. What face amount of the 5-year bond should be sold short?

The bank should short USD 100 million face of the 5-year bond. The 10-year position has a DV01 of USD 40,000, and the 5-year bond has half the DV01 per unit of face, so twice the face amount is needed to offset it.

  1. AUSD 25 million
  2. BUSD 50 million
  3. CUSD 100 millionCorrect
  4. DUSD 200 million

Explanation

Portfolio DV01 = 50,000,000/100 x 0.08 = USD 40,000. Hedge face F satisfies F/100 x 0.04 = 40,000, so F = 100 million. Selling 25 million would result from inverting the ratio, which is wrong.

Did you get it right without looking?

One question tells you little. A timed set on Regression Hedging and Principal Component Analysis shows your real accuracy, how long you take and where you lose marks.

Practise Regression Hedging and Principal Component AnalysisFree diagnostic mock

More Regression Hedging and Principal Component Analysis questions