5. (6 points) A bank has $95 million of assets with duration of 10 years, and li

Question

5. (6 points) A bank has $95 million of assets with duration of 10 years, and liabilities worth $86 million with duration of 2 years. Since the bank is concerned about preserving the value of its equity in event of an increase in interest rates, it is contemplating a macrohedge w contracts. Right now, there are plenty of T-bond futures in the market, with duration of 4 years, trading at 96-12 (i.e., $96,375). Assume that the spot and futures interest rates move together. ith interest rate futures The duration gap (DGAP) of the bank is Workout To hedge the risk, the number of futures contract to enter is Workout: Is the hedging position to long or to short futures? Workout

Explanation / Answer

1. Duration Gap (DGAP) is the difference between the duration of assets and liabilities held by a financial entity. It is a financial and accounting term and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate

DGAP = Duraion of Assets - [(Market Value of Liabilities / Market Value of Assets) x Duration of Liabilities]

=10 - [(86/95) x 2] = 8.19

2 & 3. Since the Duration Gap is Positive, we need to short the Future Contracts to fully hedge the postion

Amount of future contracts to be short =DGAP / Duration of hedging instrument x Market Value of Assets

= 8.19 / 4 x 95

= $ 194.5 million

2) No of Future contracts to be entered = $ 194,500,000 / (96,375) = 2018 contracts

3) We need to short the futures to hedge the position.

(Please thumbs up, if satisfied)

Related Questions

Navigate

• Browse (All)
• Browse 5
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.