P158 of Vol 4: If no clear opinion on int, sell int rate futures to avoid risk. why?
Very simple. If you have no opinion on whether rates are going to rise, fall or stay the same, you just want to hedge against the rate risk. Simply buying futures will accomplish this task and you will be protected against any movements in rates. This is the basic definition of hedging.
buy or sell?
You tell me. Think about it for a minute. What do you have and what you want to achieve?
if you have bond with duration 5, then in order to hedge fully, you should SELL futures to reduce the duration to 0, but that is for bond futures, right? But how do you use interest rate future?
Interest rate futures is the opposite of bond futures. When I/R rises, bond price falls and when I/R falls bond price rises. Both I/R futures and bond future can fix your price in the future.
AMC, can you take a look at the first paragraph of P158 Vol 4? It should be bond futures based on your comment?
lzhao Wrote: ------------------------------------------------------- > AMC, can you take a look at the first paragraph of > P158 Vol 4? > > It should be bond futures based on your comment? Yes, I took a look at P158 V4 before my last post. If I/R rises, bond price falls which will result in a loss but I/R futures will gain, then the loss and gain will offset. The bond can be hedged (you just want to protect from a loss rather than earn a profit, this so called “hedge” as derswap07 said).
why interest rate futures gain when the int goes up? Note that you are selling the int futures.
Selling I/R future (not option) means you have a right & obligation to lend at a contracted I/R, so you gain when I/R falls.
it helped me to understand that the i/r future is based on treasury securities, focus on treasury security rather on I/R makes a lot of things on this chapter easier to understand. bottom line is to hedge risk of bond, reduce duration, so hedged portfolio’s price doesn’t change with i/r. it might help to go over some CFAI’s EOC questions, some of them required calculation effective duration of the hedged position.