You are a financial manager, and you have bonds worth $1,550,000 in yourportfolio which have a 7 percent coupon rate and will be maturing in 10years from now. The market rate is also 7 percent but is likely to eitherrise to 8% or fall to 6%Based on the above information, answer the following questions:i) What type of risk you are exposed to? ii) How can you hedge your exposure using the information in partsiii) and iv) below? iii) Suppose a call and put option on these bonds is available withan exercise price of $1,700,000. These contracts are availablein standard contract sizes of 100 options per contract at aprice of $5 per contract. Show the net impact of a change inmarket rates if options are used for hedging the exposure. iv) If a futures contract on these bonds is available with a standardcontract size of $155,000 per contract, show what will be thenet impact of a change in market rates if futures are used forhedging the exposure. v) Which hedge provides better results? Why?
You are a
portfolio which have a 7 percent coupon rate and will be maturing in 10
years from now. The market rate is also 7 percent but is likely to either
rise to 8% or fall to 6%
Based on the above information, answer the following questions:
i) What type of risk you are exposed to?
ii) How can you hedge your exposure using the information in parts
iii) and iv) below?
iii) Suppose a call and put option on these bonds is available with
an exercise price of $1,700,000. These contracts are available
in standard contract sizes of 100 options per contract at a
price of $5 per contract. Show the net impact of a change in
market rates if options are used for hedging the exposure.
iv) If a futures contract on these bonds is available with a standard
contract size of $155,000 per contract, show what will be the
net impact of a change in market rates if futures are used for
hedging the exposure.
v) Which hedge provides better results? Why?
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