Hedging Bonds
- Risk Management
The bond-hedging lab combines duration, futures, and forward positions. A portfolio can be made locally insensitive to a yield move by matching its dollar duration with an offsetting instrument.
The hedge has to match the exposure being measured. A bond's price, accrued interest, maturity, coupon, and day-count convention determine the sensitivity; a futures contract adds its own conversion factor and basis. Matching only the face amount can leave a large residual rate exposure.
The notes use this as a practical version of the earlier lesson: a hedge is a model of a risk, and the model must be re-estimated as the portfolio and the curve change.