# 2 Bond Hedge

The calculation of this hedge is killing me. Do we really need to know? LOS says no but I have read somewhere that they asked to calculate last year, correct? Any easy way to remember this huge calculation step?

They did ask it last year, but I’m still not going to waste my time trying to learn it…one of the few times I am punting a topic. Understand the basics and you can probably kick out one answer.

The only thing I know is to short 2 bonds - one short duration and other long duration. Hopefully they may not ask this as it is covered in last year’s test. But you never know:(

or the futures.

They asked the futures too? That is easy but they can get you by giving unnecessary information like cash duration and half of us will make a mistake. Just give some easy questions this year on FI. C’mon CFAI!

The way Schweser explains it makes my eyes cross. Does anyone have a simplified explanation of what they’re doing here? If not I might try and break it down myself later this week but that seems rather messy.

Don’t recall them asking about futures, just saying that is another acceptable way to hedge the long and short end.

Aimee, Check out the CFAI reading on this, it’s about 6 pages and very logically walks through the steps, much more clear than Schweser I thought. I just spent part of my lunch hour reviewing this and have a much better feel for it now. Mathematically, it’s tedious, and there are a lot of steps, and I don’t see myself spending a ton of time to learn how to do it from beginning to end, but understanding the logic and the qualitative stuff just may get you some points should they go there. 35 minutes well spent for me.

I get how to do everything except for solving the two equations at the end. My algebra skills have evaporated from 8th grade.

It just comes down to solving 2 simultaneous equations people…

someone plz remind me of these 2 equations…i forgot to write them in my books and dont have the textbook in front of me… i recall negating the right-hand side term for both equations? correct?

If you hadn’t figured it out by now, CFAI does a much better job in the FI sections. I would suggest reading them over Schweser.

H2 * (AvgPriceDeltaH2BdLevel) + H10 (AvgPriceDeltaH10BdLevel) = - -AvgMBSPriceDelta Level (Same equation as above for the twist). 2 unknowns, 2 equation system. Very straightforward

Okay, so from the example in the book H2(.418) + H10(1.687) = -1.274 H2(.312) + H10(.472) = -.237 They then proceed to solve this in about 10 steps, that I can’t figure out. Any kind soul care to show how this is done like your explaining it to a mental midget?

take the first equation and solve for H2. You will get: H2 = [-1.274 - H10(1.687)] / 0.418 Now plug this into the second equation and solve for H10. Once you solve for H10, plug that number into either equation (or the one I posted above) to get the value for H2.

where do the deltas come from? they give them to you?

Solving simultaneous equations H2(0.418) + H10(1.687) = -1.274 — Eq1 H2(0.312) + H10(0.472) = -0.237 ---- Eq2 Mult Eq1 by 0.312 H2(0.418)*(0.312) + H10(1.687)*(0.312) = -1.274*(0.312) H2(0.130416) + H10(0.526344) = - 0.397488 ---- Eq3 Mult Eq2 by 0.418 H2(0.312)*(0.418) + H10(0.472)*(0.418) = -0.237*(0.418) H2*(0.130416) + H10(0.197296) = -0.099066 ---- Eq4 Subt Eq3 with Eq4 H2(0.130416) + H10(0.526344) - H2*(0.130416) - H10(0.197296) = - 0.397488 + 0.099066 H10(0.526344) - H10(0.197296) = -0.298422 H10*0.329048 = -0.298422 H10 = -0.9069254 — Eq5 Subst Eq5 in Eq1 H2(0.418) + (-0.9069254)(1.687) = -1.274 — Eq1 H2(0.418) -1.5299831498 = -1.274 H2 = 0.6123998799

you have to think about what is going on in the big picture basically you’re setting up one equation for the hedge ratios of the the 2 yr and 10 yr based on yield curve shifts, and one equation for the hedge ratios based on yield curve twists. you’ll always be given the prices before and after the yield curve shifts/twists, just remember that the coefficients of the hedge ratios (H2 and H1) and the value of the MBS price represent the average price changes for the MBS, 2 yr and 10 yr securities. always set the MBS change equal to the sum of the products of the hedge coefficients and the hedge ratios. now you have two equations, two unknowns and can solve the system for the hedge ratios.

Sponge_Bob_CFA Wrote: ------------------------------------------------------- > They did ask it last year, but I’m still not going > to waste my time trying to learn it…one of the > few times I am punting a topic. Understand the > basics and you can probably kick out one answer. Cosign. Call me Sean Landetta; not going near this shit with a ten foot pole.

Wasn’t on there last year after Schweser said like exactly in their notes that it wouldn’t be asked on the exam. So I don’t know. Anyway, the explanation in the CFAI materials is pretty good. Actually pretty easy after I read it, just fcuked me last year because the clowns at Schweser specifically said calculating it wouldn’t be on the exam so I didn’t study them.