2-bond hedge - why use par value, not market value?

CFA Level III
#1

“The value of 0.612478 for H2 means that the par amount in the 2-year Treasury note futures will be 0.612478 per $1 of par amount of the mortgage security to be hedged. So, if the par amount of the Fannie Mae 5% to be hedged against interest rate risk is $1 million, then …” (Institute 164) Institute, CFA. Level III 2013 Volume 4 Fixed Income and Equity Portfolio Management. John Wiley & Sons P&T, 6/18/2012. vbk:9781937537364#page(164). We calculate the hedge based on market value changes. Why then are we considering par values here?

#2

The hedge ratio is calculated to automatically adjust to the market price movements . hedge ratio is calculated on PVBP and you work out the number of contracts required from the par values and the hedge ratio . The par value is a scale factor to get the # of contracts worked out for the futures . That is how the exchange defines the contract itself ( in terms of dollar par value )

See Fabozzi’s power point here ( page 44 )

https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=6&ved=0CF8QFjAF&url=http%3A%2F%2Fwww.faculty.fairfield.edu%2Fnlaopodis%2FFabozzi_Ch27_BMAS_7thEd.pptx&ei=u7VpUaPONeaMyAH964HoDw&usg=AFQjCNH8PAVzU-pP8USUGsNxkiHVSJO_hQ&sig2=6Qadu1bHpvQVB8prgYAkdA&bvm=bv.45175338,d.aWc

#3

Thanks very much, Janakisri, as always, for sharing your insights!

#4

we help each other . that’s what the forum is for.