What happens if the bond portfolio has not been hedged

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Reference no: EM132206379

Question - An investor holds 100,000 units of a bond whose features are summarized in the following table. He wishes to be hedged against a rise in interest rates.

Maturity	Coupon Rate	YTM	Price
18 years	9.50%	8%	114.181

Characteristics of the hedging instrument, which is here a bond are as follows:

Maturity	Coupon Rate	YTM	Price
20 years	10%	8%	119.792

Coupon frequency and compounding frequency are assumed to be semiannual. YTM stands for yield to maturity. The YTM curve is flat at an 8% level.

1) What is the quantity of the hedging instrument that the investor has to sell?

2) We suppose that the YTM curve increases instantaneously by 0.1%.

(a) What happens if the bond portfolio has not been hedged?

(b) And if it has been hedged?

3) Same question as the previous one when the YTM curve increases instantaneously by 2%.

4) Conclude. (Hint: you might want to think about the role of convexity here.)

Reference no: EM132206379

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