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FRM Part I · FRM Exam Part I · Modeling Non-Parallel Term Structure Shifts and Hedging

A risk manager hedges a bond portfolio with a single futures position sized so that its DV01 equals the portfolio's DV01. Which statement best describes the protection this hedge provides?

A single DV01-matched hedge protects against small parallel yield curve shifts only. If the curve steepens, flattens or twists, the portfolio and hedge have exposures at different maturities, so a residual gain or loss remains. Multi-factor hedging needs additional instruments to match key-rate exposures.

  1. AIt protects against parallel shifts in the yield curve, but a change in slope or curvature can still leave a residual gain or lossCorrect
  2. BIt protects against level, slope and curvature changes simultaneously, because DV01 captures every factor
  3. CIt protects only against changes in credit spreads, because DV01 is a spread measure
  4. DIt protects against non-parallel shifts but not against parallel shifts

Explanation

A DV01 match neutralizes the first-order price effect of a small parallel shift. Because the two positions can have exposures concentrated at different maturities, a steepening or twist produces different gains and losses on each. Hedging several factors requires at least one instrument per factor, such as key-rate exposures.

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