My question is realted to reading 31 in this year book 4 versus reading 29 in last year book 4 (which I am still using since I have not registered yet) My question is realted to problem # 3. The answer that CFAI gives for Cosultant C,which is :" If one has no clear opinion about the interest rate outlook but like to avoid risk, selling interest rate futures would be a good a good strategy. If interest rates were to decline, the loss in value of bonds would be offset by gains from futures contracts". I am really confused by the above statement. How would that be? because when rate decline, the value of the bond will increase an you sell future, you must delivered the bond at contract maturity date . In addition, the price of an interest rate future contract are negatively correlated with the change in interest rates, therefore, when interest rates drop, the price of the deliverable bonds will rise and futures contract will increase. Enough said, please help, I am confused. Maybe it is just me.
Basically if you have no opinion and would like to hedge risk, you can do that by selling futures. You end up with a portfolio that is long bonds and short futures. By choosing the appropriate ratio, duration will be equal to zero -> portfolio is not sensitive to interest rate moves.
maratikus: But I tought in that case the best course of action is buying futures because if Interest decline, you want to increase you duration. Also, the part I do not understant is “If interest rates were to decline, the loss in value of bonds would be offset by gains from futures contracts”. If I have a bond portfolio is interest rate decline, I should have to loss money. Am I correct or Not? I know that I will a reinvestment risk because i will have to reinsvest counpon with a lower rate but the increase in value for the bond should be more that offset that. you see my point. Maybe, i take it too far.
you are long bonds, you sell bond futures (here they call those interest rate futures) to reduce duration.
Agree that I am long, but if you are long and suppect interest will decline, i think that I would have bought interest future to increase duration according to duration management section 5.3.4.1 in the book.
you are correct, tibwa. that was definitely a typo in the book. if you are not sure about interest rates, you can hedge that risk by selling futures. if interest rates decline, bonds gains will unfortunately be offset by losses in futures. However, if rates increase, bonds losses will be offset by gains in futures. if you knew for sure that interest rates will decline, there is no reason to sell futures.
Oops - send an e-mail to whoever does errata…
maratikus et Tibwa I have read this material and it just does not settle with me… I will go back to it but you guys are certainly going to play a big role in helping me crack this nut. Deal? say Yes!!!
I have take a break from it too. I will go back to it this weekend and see what wrong with it or with me. Either way, it is going down. I cannot afort not to understand anything this time.
tibwa, For a portfolio manager, worst case scenario if not hedged is : " If interest rate increase, the value of the portfolio will go down". If interest rate goes up, then the future contract price will go down. ( 100 - interest rate). So if you sell futures, you can offset the losses from your bond portfolio with gains from futures. ( if hedged perfectly) So the best strategy if one has no clear opinion about the interest rate outlook is to sell futures ( if long bonds) Hope this helps
amit_cfa2: I definitely agree with you and maratikus as well but my point is in this sentence according to the solution of the problem 3 reading 29 ( last year book) “If one has no clear opinion about the interest rate outlook but like to avoid risk, selling interest rate futures would be a good a good strategy. If interest rates were to decline, the loss in value of bonds would be offset by gains from futures contracts”. I agree to sell futures but I do not agree with part of the statement that said"If interest rates were to decline, the loss in value of bonds would be offset by gains from futures contracts" because when interest decline, the value of bond portfolio will increase. You see my point. Maybe this year materiel does not have that mistake. i am going to register next and i will the new books. Meawhile can you verify that statement is still the same. In interest rates were in fact to decline, you would have gain from the bond portfolio and loss from selling the futures contracts. And I also understant that action could offset each other. thanks
tibwa, In 2009 text, the statement has been revised as follows. If interest rates were to “increase”, the loss in value of bonds would be offset by gains from futures contracts". So, its CFAI’s error in 2008 text.
Thank you so much AMC I feel so relieve by the fact it was a mistake of last year book. I was so mad by that statement.
tibwa thanks for sharing…initially i was also curious why a port mgr is concerned of rising bond px (or falling interest rate).