Handbook question 17.7

[[email protected]]

Hi David,
I found an explanation of this question here http://www.bionicturtle.com/wiki/FRM2009.L1.14/.

My questions are:
1. In the hedge ratio formula, 0n the top, the duration of portfolio is its duration at maturity. Is the duration in the denominator also the duration of futures at maturity?
2. In this question, it also gives that the duration of the underlying benchmark treasury bond is 9 years. What is this benchmark treasury bond? Is it non-related info?

Thanks.

 

[David Harper CFA FRM]

Hi ldcn,

1. Yes, ideally, the duration hedge (ratio) wants the durations and maturity for both the underlying and the hedge; i.e., even the portfolio value wants to be a forward value, so the whole ratio is consistent
2. Yes, GARP sneakily added that tempting answer. The short won't actually deliver the 9-year treasury bond, the short has a choice among a basket of roughly similar T-bonds to deliver (necessary to liquidity). Technically, therefore, we want the duration of the cheapest-to-deliver, if that info is available. It's not wrong to use the 9-year treasury bond because EX ANTE we don't know the CTD, if you think about it! So, i think this is a mean question, bordering on unfair to include the additional duration question. (It's very textbook but i'm not sure it's reality based)

Hope that helps, David

 

[[email protected]]

Thanks a lot! I am afraid the FRM in November will have quite a few mean questions since I heard the exam in May is not so hard....

 

[David Harper CFA FRM]

Oh, that's interesting but i am not sure i can understand why May should be easier, that is news to me ... (but in any case, even if it were, it totally grades on a curve).