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CMA Final · Strategic Financial Management · Interest Rate Derivatives

A mutual fund holds a bond portfolio of Rs 50 crore with modified duration 4.8. It wants to hedge against a rise in yields using interest rate futures, each contract having a value of Rs 1,00,000 and a modified duration of 6.0. Using the duration-based hedge ratio, what position should it take?

The fund should sell 4,000 futures contracts. The hedge ratio is portfolio value times its duration divided by contract value times its duration, giving 4,000. A short position is needed because futures profit when yields rise, offsetting the bond losses.

  1. ASell 4,000 contractsCorrect
  2. BBuy 4,000 contracts
  3. CSell 5,000 contracts
  4. DSell 6,250 contracts

Explanation

Contracts = (50,00,00,000 x 4.8) / (1,00,000 x 6.0) = 24,00,00,000 / 6,00,000 = 4,000. Rising yields lower bond prices, so the fund must sell (short) futures to gain offsetting profits. 5,000 ignores the duration ratio, and 6,250 inverts the ratio (6.0/4.8).

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