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CMA Final · Strategic Financial Management · Interest Rate Derivatives

A treasury manager holds a bond portfolio with a price value of a basis point (PVBP) of ₹80,000, meaning its value falls by ₹80,000 for each 1 bp rise in yields. An interest rate futures contract has a PVBP of ₹2,000 per contract, and its price moves with the portfolio's yield. To hedge against a rise in interest rates, what should the manager do?

The manager should sell 40 futures contracts. The portfolio loses ₹80,000 per basis point rise, and each short contract gains ₹2,000 per basis point, so 80,000 divided by 2,000 gives 40. Selling, not buying, is needed because rising yields cut futures prices.

  1. ASell 40 futures contractsCorrect
  2. BBuy 40 futures contracts
  3. CSell 20 futures contracts
  4. DSell 80 futures contracts

Explanation

A rise in yields hurts the portfolio and also lowers futures prices, so a short futures position gains and offsets the loss. Contracts needed = portfolio PVBP / futures PVBP = 80,000 / 2,000 = 40. Buying would add to the loss. Selling 20 or 80 hedges only half or twice the exposure.

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