Can anyone help me out with this thing. I get you are trying to hedge twists in the yeild curve when holding a negative convexity security with a longer and shorter duration bond position. What I don’t get is how are you supposed to determing whether to short or long the bonds? Are you always supposed to short the bonds?

I do not think there is any general rules like always short the bonds (at least I dont remember reading it in CFAI). The only way I know of is to solve the equations. But maybe someone else know a cool trick for this

two examples in CFAI: short/long short/short there’s a really good thread on this but i can’t find it, something to do with durations as far as i remember

Dude, i thought you always short the two bonds if you are long the MBS. Anyone? and explanation would be appreciated…

if the curve was inverted, i think short/long might work actually. not sure what CFAI example says.

If you are long the MBS and wish to hedge the position you need to short two bonds, one short term bond and one long term bond.

i have question further. How barbel strategy or bullet strategy was to be secleted ? are there any rules?

Try not to get a headache - all the subscripts dont really translate A two bond hedge involves shorting bonds or futures of different maturities, usually a the 10-year and the 2-year. This will simultaneously hedge the mortgage security’s price response to both “level” and “twist” scenarios. Steps for a 2-bond hedge 1. For an assumed shift in the level of the yield curve, compute: a. Price of the mortgage security for an increase or decrease b. Price of the 2-year treasury note for an increase or decrease c. Price of the 10-year treasury note for an increase or decrease 2. Calculate the price changes that occur in step 1 3. Calculate the average price change for the mortgage security and the two hedging instruments assuming that an increase or decrease are equally likely a. H2PriceL = average price change for 2-year for a level shift b. H10PriceL = average price change for 10-year for a level shift c. MBSPriceL = average price change for an MBS for a level shift 4. For an assumed twist in the level of the yield curve, compute: a. Price of the mortgage security for an steepening or flattening b. Price of the 2-year treasury note for an steepening or flattening c. Price of the 10-year treasury note for an steepening or flattening 5. Calculate the price changes that occur in step 4 6. Calculate the average price change for the mortgage security and the two hedging instruments assuming that a steepening or flattening are equally likely a. H2PriceT = average price change for 2-year for a twist b. H10PriceT = average price change for 10-year for a twist c. MBSPriceT = average price change for an MBS for a twist H¬2*H2PriceL + H10 * H10PriceL = - MBSPriceL H¬2*H2PriceT + H10 * H10PriceT = - MBSPriceT Where PriceL and PriceT are the average price changes in each instrument for a level or twist – MBS is negative because remember you are hedging. The idea here is to solve for one variable, (H2) for instance and put the level equation in terms of H2. H¬2 = (- MBSPriceL – (H10 * H10PriceL)) / H2PriceL Plug the H2 equation into the twist equation to solve for H10 [(- MBSPriceL – (H10 * H10PriceL)) / H2PriceL]*H2PriceT + H10 * H10PriceT = - MBSPriceT Plug H10 back into the H2 equation and solve.

what part of schweser is this?? book or page. thanks

While I appreciate JScotts efforts there, that is not worth the potential 3 points I could lose. THAT, is as ugly as it gets.

If you are long MBS, you don’t always short both treasuries. Sometimes you have to go long on one of them. It depends on how the mbs and T’s react to shifts and twists in the yield curve. I don’t know of a short cut to figure it out either. The only way I know how to tell is by doing the whole process… I recommend reading CFAI text - they have an example of each.

Big Babbu Wrote: ------------------------------------------------------- > While I appreciate JScotts efforts there, that is > not worth the potential 3 points I could lose. > THAT, is as ugly as it gets. The calculation is definitely not required. This was in the CFA texts, its just so you can get an idea of what exactly its doing