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CMA Final · Strategic Financial Management · Interest Rate Derivatives

Sagar Mutual Fund manages a bond portfolio of ₹100 crore with a modified duration of 6. It wants to hedge against a rise in rates using interest rate futures, each contract having a value of ₹10 lakh and a modified duration of 4. Assuming equal yield changes across both, what position is required for a full duration hedge?

The fund should short 1,500 futures contracts. The hedge ratio is the portfolio's duration-weighted value divided by that of one contract, which gives 1,000 contracts scaled by 6/4. Shorting offsets losses in the bond portfolio if interest rates rise.

  1. AShort 1,500 contractsCorrect
  2. BLong 1,500 contracts
  3. CShort 667 contracts
  4. DShort 1,000 contracts

Explanation

Number of contracts = (portfolio value × portfolio duration)/(futures value × futures duration) = (100 crore × 6)/(10 lakh × 4) = 1,000 × 1.5 = 1,500. The fund loses when rates rise, so it must sell futures, giving a short position. 667 inverts the duration ratio, and 1,000 ignores the duration difference.

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