Interest rate futures

CFA Level I Derivatives
#1

Guys I think this might be level 2 but Im not sure. Its a question from my derivatives course at my university.

A portfolio manager will only have the funds to purchase bonds in three months time, but has come to the conclusion that the capital market interest rates will decline in the future. Consequently, the manager decides to hedge by using a future on the R153 bond to hedge against a price change.

15 February Details:

Yield to maturity: 16.1%

Price of bonds: R 70 690.61

Yield to maturity of R153 futures contract: 16.25%

Price of R153 futures contract: R 70 051.59

On the 15th of June the values have changed:

Yield to maturity: 16%

Price of bonds: R 71 381.94

Yield to maturity of R153 futures contract: 16.15%

Price of R153 futures contract: R 70 525.40

Assume the treasury manager offsets his position on the 14th of June. Indicate what steps the manager may take on the 15th of Feb to hedge against the interest rate decline and indicate the steps the manager may take to unwind his position on the 15th of June.

I understand that a long futures contract is entered into as an interest rate decline will make the bonds more expensive. But Im confused as to what else happens.

#2

Does anyone know what to do?

#3

Well the funds aren’t available and the interest rate is going to decline. This means that the bond price will be relatively more expense as rates decrease. So you can buy the long future to hedge against this price increase.

Your initial cash flow would be 0, as nothing is happening in the cash market. You have no funds now and you are purchasing a futures contract.

At the 15th of June you would close your position by reversing your trade. I.e. Sell the futures contract.

This would net you a profit of 473.81.

(70525.40-70051.59)

However as the bonds are 691.33 more expensive your hedge is only 68.53% effective