Duration Hedging, page 109 - 111, curriculum

Anyone can help me understand these questions as follow?

  1. At the begining of page 110, it says: " the outcome of a hedge will depend on the relationship between the cash price and the futures price both when a hedge is placed and when it is lifted".

I don’t understand " what is cash price" here? what is the role of cash position in this portfolio. Totally lost with that.

  1. In page 110 " factor exposure of the bond to be hedged, referred to in the “hedge ratio” formula is the dollar duration of the bond on the hedge lift date, calcuated at its current implied forward". Could you help me understand this statement?

Thank you very much!

Cash price is spot price, the price you pay to take delivery right now , not defer delivery to future. Since you are invested in the asset your position value is tracked through the spot price (called cash price here) .the hedge on the other hand is a futures instrument so it’s value depends on the difference between futures pricsheen the day you lay the hedge on and when you unwind or take it off .any given day you can mark-to-market the futures position to understand how the hedge is doing.

The second point has to do with sensitivity or effectiveness of the hedge.for example if you try to hedge a long duration bond with a future contract which is based on a deliverable bond with lower duration , then obviously for same notional the futures contract will not be as sensitive to interest rate changes , and you will need more contracts I.e go for higher effective notional to hedge the rate sensitivity of your portfolio bond .in this manner the hedge would be constructed to neutralize the factor sensitivities such as level, convexity or twist in yield curve

Thank you so much for your big help.