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

A trader holds a long position in a bond portfolio with a DV01 of USD 42,000 per basis point. She wants to hedge using a Treasury futures contract whose DV01 is USD 70 per contract per basis point, assuming parallel yield shifts. Which position neutralizes the interest rate exposure?

Short 600 futures contracts. The number of contracts equals portfolio DV01 divided by contract DV01, 42,000/70 = 600. Because the bond portfolio loses value when yields rise, the hedge must be short futures so that gains offset the portfolio loss under parallel shifts.

  1. AShort 600 contractsCorrect
  2. BLong 600 contracts
  3. CShort 1,667 contracts
  4. DShort 60 contracts

Explanation

Hedge ratio = 42,000 / 70 = 600 contracts. The portfolio loses when yields rise, so the hedge must gain when yields rise, which requires a short futures position. Short 1,667 inverts the ratio (70/42,000 scaled incorrectly) and is wrong; long adds exposure.

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