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

A portfolio has a DV01 of USD 90,000. The hedge instrument has a DV01 of USD 60 per contract. A regression of historical changes in the portfolio yield on changes in the hedge instrument yield gives a beta of 1.20 (portfolio yield change per unit hedge yield change). What is the number of contracts to short under the regression hedge?

Short 1,800 contracts. The regression hedge scales the DV01-matched quantity by beta: 90,000/60 = 1,500, multiplied by 1.20 gives 1,800. Because portfolio yields move 1.2 times as much as the hedge yield, more hedge is required than the simple DV01 match.

  1. A1,250
  2. B1,800Correct
  3. C1,500
  4. D1,200

Explanation

Regression hedge: contracts = (DV01 portfolio / DV01 hedge) x beta = (90,000/60) x 1.20 = 1,500 x 1.20 = 1,800. A DV01-only hedge gives 1,500, ignoring beta. Dividing by beta gives 1,250.

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