Hi, I have a question regarding 2013 L2 Mock exam question# 9, in the short passage, it says: Kwon buy a 5% semi-annual coupon bond and concerns about the increase of interest rate, therefore, Parisi asks him to short a forward contract. However, I think Kwon should long a forward contract to hedge the risk of increase of interest rate for the bond. Please enlighten me, thanks.
if int rate goes up, the bond price goes down. he’s already long bond. so to protect himself from losses when the bond prices go down, he should short the forward.
remember: if you are long asset, then to hedge short forwards/futures. if you are short asset, then to hedge long forward/futures.
thanks for your reply,
I thought he is short the market interest rate (receiving the fixed coupon payment and have a gain if market interest rate drops), therefore he concerns about market interest rate goes up. Thanks for you explanation.
also, he is long the bond, if interest rates goes up, bond value decreases. To hedge the risk, he should gain from the increase of interest rate. So, he should long the forward interest rate.
A forward contract on what: interest rates or bonds?
should be forward contract on bonds instead of interest rate, then it makes sense.
please explain q no 17 in Afternoon session
Will not buying a bond then shorting future make it neutral?
I think he has to shrot it when he things he has made profit and dont want to loose profit by the downturn?
Correct me if I am wrong…