Reading 30 in CFAI Readings (p57 of Volume 4) “Interest rate risk of mortgage can be hedged directly by selling a package of T-notes or T-note futures” - I agree “By hedging interest rate risk, a manager synthetically creates a Treasury bill and therefore earns the return on a Treasury bill” - don’t agree. Or rather, don’t understand. If manager sells synthetically created T-bill, why is he the one earning return on T-bill (and not the buyer of T-bill)?
By hedging interest rate risk, a manager synthetically creates a Treasury bill and therefore earns the return on a Treasury bill" … Synthetic would mean he creates a position ( using derivatives ) where in he will recieve a T bill return …I dont believe he actually sells the synthetic postion …
But isn’t the position receiving T-bill return equivalent to buyint T-bill, not selling? And to hedge he needs to sell, no?
What they are essentially saying is that once you hedge your position you’re left with a return on a T-bill…basically by hedging interest rate risk, you have essentially created a T-bill and you are getting T-bill return.
But of course hedging mortgage-backed securities with t-note futures is not likely to give you anything close to T-bill returns so it’s kind of an empty statement.
“By hedging interest rate risk, a manager synthetically creates a Treasury bill and therefore earns the return on a Treasury bill” (For MBS!?) Well, if it’s perfectly hedged it just might do that… but then you realize this is the real world and that convexity, cross hedging issues, prepayments, and defaults apply. However, in theory if you create a synthetic cash position, it should earn the risk free rate, which is essentially the return of a t-bill.