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FRM Part I · FRM Exam Part I · Interest Rates

A DV01-based hedge using a single futures contract is most likely to leave residual risk when:

Residual risk is most likely when the yield curve twists. A single-contract DV01 hedge assumes a parallel shift, so if short and long rates move in opposite directions, the bond and futures gains and losses no longer offset each other.

  1. AThe yield curve moves in a perfectly parallel fashion
  2. BThe hedged bond and futures have identical durations
  3. CThe yield curve twists, with short and long rates moving in opposite directionsCorrect
  4. DThe hedge ratio is rebalanced daily with a parallel shift

Explanation

A DV01 hedge assumes parallel shifts in the curve. If short and long rates move differently (a twist or steepening), the hedged position and the hedge instrument respond differently, leaving basis or curve risk.

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