You are a financial manager, and you have bonds worth $1,550,000 in your 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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