Answer to Question #123092 in Accounting for Emily

Question

II.
Bob has asked you to bring your bank’s current list of assets and liabilities to the study session to use in setting up both a micro and a macro hedge. A summary of your bank’s position is as follows:
• Total assets: $150 million
• Duration gap: 2.20 years
• Primary holdings of concern: $7 million in 6% Canada bonds selling at par that will mature in 5 years
• $12 million in stocks with an average beta of 0.90
Historical relationships between Canada bond futures contracts and Canada bonds indicate that the change in the value of the hedged asset relative to the futures contract would be about 1.3 and that interest rates on the hedged asset change on average for a given change in the interest rate on the futures contract by about 0.90. A 1% increase in interest rates results in a decline in value for Canada bonds of 8% of par.
1. If you expect interest rates to rise, what type of hedge should you set up, long or short? 2. How many futures contracts are needed to set up a complete hedge?

Answer 1

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