Hey guys, I’ve a question regarding the ‘Fixed Income Portfolio Management Part II’ section in schweser. On page 77 it takes the hedge ratio (exposure of bond to risk factor/exposure of futures to risk factor) and breaks it out into: exposure of bond to risk factor/exposure of CTD to risk factor multiplied by exposure of CTD to risk factor/exposure of futures to risk factor. It then states that the second term represents the conversion factor for the CTD bond. I don’t see how that term (exposure of CTD to risk factor/exposure of futures to risk factor) equals the conversion factor. Can anyone shed some light?
Assuming we are talking about exposure to interest rate (as risk factor), use dollar duration as the ‘exposure’. Definition of CTD: CTD price = futures price* conv factor. this translates to DDf = DDctd/conv factor (see pg 75) therefore, exposure of ctd/exposure of futures = conv factor - bn
hi, can someone explain what is the significance of the formula?
hedge ratio = [exposure of bond to risk factor/ exposure of CTD to risk factor] x [exposure of CTD to risk factor/ exposure of futures to risk factor]
is it an intermediate step to obtain the following formula?
hedge ratio
= [(D_P*P_P/(D_CTD*P_CTD)]*(CTD conversion factor)