In session 9 (fixed income) they talk about dynamic hedging (hedging prepayment risk on mortgage securities) and how it’s a catch up game because when rates go down so does the mortgage security duration and you have to BUYBACK FUTURES AT A LOSS? I dont understand … Also on a flipside when rates go up so does the duration and you have to sell more futures at lower prices ? I don’t understand how this works. somebody shed some light pretty please?
when rates go down, prepayment kicks in. it is very likely to be called. so the duration goes down. now, you are already hedging the morgage by selling futures. thus you have to buy back futures at a loss. ( meaning interest goes down, price goes up, in this case slightly up but you are still buying back at higher price then you sold previously so there is loss)
thanks, I think I get it now, rates go down and so does the duration, you need to buy back futures to lenthen the duration (prices up so you are buying back at a loss) rates go up and so does the duration, now you need to shorten the duration so you sell the futures but because the price is down due to due to higher rates you sell at a slight loss eureka!!! thanks!
rates go up and so does the duration, now you need to shorten the duration so you sell the futures but because the price is down due to due to higher rates you sell at a slight loss huh? were we long the futures? where does the loss come from exactly?