Hedging mortgage security with a short Treasury futures

Help please. Assumed that if I short a Treasury futures,I am hedging against a fall in

the value of a my portfolio of mortgage securities-and so my mortgage security would

be trading ABOVE par?

Hedging a mortgage security with a short Treasury futures contract is most effective if: A) it is trading above par. B) it is trading at par. C) it is trading below par. -------------------------------------------------------------------------------- C If the security is trading below par, then it is most likely to exhibit positive convexity, and this will make a hedge formed with a Treasury futures contract that has positive convexity more effective

If security is trading below par => market rate or YTM > coupon of the bond = > the call option is out of money hence MBS likely to exhibit +ve convexity.

So heding MBS with T future will be effective as in movement in both are likely to cancel out each other if interest rate changes.

Hedging MBS when the security is trading above par wont be effective, because of negative convexity. If it is below par, you are still exhibiting positive convexity.

So, if its above par and rates go down, you loose money in the futures.You would expect an offset in this loss by the gain of the MBS, but since it has negative convexity it wont gain as much value as you lose on the futures, making it an innefective hedge.

If it is below par and rates go down, since convexity is still positive at that point, the hedge will work better because the increase in value of the MBS will offset the loss from the futures.

MBS is directional security , not ideally hedged with a forward or futures if you’re uncertain of the direction of volatility.

Better to use options if you’re unsure .