Is the point of the 2 bond hedge (short 2 non-callable bonds when you own a MBS) to elimininate interest rate risk? Does that mean your return on your portfolio is similar for a decrease and increase in rates?
Both the change in the level and the twist of the curve.
except if its crispy.
cuspy
mmmmm…crispy…where’s my breakfast…
what about hedging with a 1 bond future?
if the bond doesn’t have negative convexity… then you’d just use one bond future…
you mean a non-callable is hedged with 1 future bond. a mbs with 2 future bonds.
YOU DONT NEED 2 BONDS JUST BECAUSE YOU HAVE NEGATIVE CONVEXITY!!! THINK: Callable bullet! THANKS!
After this test, I’m going back to equities! 
bchadwick Wrote: ------------------------------------------------------- > After this test, I’m going back to equities! i work in equities derivatives 
CSK, is that where you derive your knowledge from?
bigwilly Wrote: ------------------------------------------------------- > CSK, is that where you derive your knowledge from? i am a programmer dude, come on, i am just good with maths and internets
haha…didnt know if you made a career change or not
anyone else working in equity deriv besides CSK?
thread hijacker
csk - A callabe bullet is a bit different from an MBS in the sense that with the bullet you are only receiving interest payments, whereas with the MBS you are getting both principal and interest. In addition to the negative convexity of the MBS, there is also the fact that peope sell their homes after an average of 10 years. Is that why you hedge with the 2 futures on an MBS and only one on the callable bullet?
jimmylegs Wrote: ------------------------------------------------------- > csk - > > A callabe bullet is a bit different from an MBS in > the sense that with the bullet you are only > receiving interest payments, whereas with the MBS > you are getting both principal and interest. In > addition to the negative convexity of the MBS, > there is also the fact that peope sell their homes > after an average of 10 years. Is that why you > hedge with the 2 futures on an MBS and only one on > the callable bullet? jimmy,yes CFAI states that the reason for 2 bond hedge 1) cash flow changes as people start to prepay when interest rate drops (probably short term as oppose to long term) 2) mortage is amortized. it never says that negative convexity is the reason for 2 bond hedge
My understanding was that you can hedge duration with pretty much a single bond. If you want to hedge duration AND convexity, you need two bonds to do that (two degrees of freedom used to hedge two parameters). With a MBS, you have callable securities giving you negative convexity, so you need to use long bonds to provide a convexity hedge. However, you’re also getting a lot of principal back earlier than with an ordinary coupon bond, so the duration is shorter than an ordinary bond. As a result, you need the long bond to provide convexity, and you need the short bond to reduce the duration. A perfect hedge would presumably be by selling some other MBS, but since you’re likely to be using futures, which have ordinary bonds as underlyings, you do this two-bond hedge thing. I am more or less skipping the calculation part and praying they don’t ask me to do it.
CSK, what is callable bullet ? I thought bullet means noncallable bond. I aggree with Bchadwick. In case of MBS you need two bonds hedge in order to: 1) to avoid loss on hedged position if % goes down (due to negative convexity) 2) to hedge against twists (not only shifts) Hence I suppose we could assume that if we have conventional callable bond in spite of the fact we don’t care about twists here we still need to address negative convexity (to avoid loss) -It means we’ll also use two-bond hedge. Please correct me if I’m wrong