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PQ-external Hedging, Bonds & Yield Based Hedging

Hello,

Please help me with the following questions :
What is value required to hedge a key rate exposure of $27.5 with another security with key rate exposure of $9.75, both having similar face value?
Choose one answer.
a. 35.45 Incorrect
b. 282.05 Correct
c. 37.25 Incorrect
d. 268.13 Incorrect
The correct answer is B
F = 282.05 [(27.50/ 9.75)*100]

What is the use of value 100?

2) Empirically, a nominal yield would adjust by more than ____ basis point for every basis point adjustment in real yield.
Choose one answer.
a. zero Incorrect
b. one Correct
c. ten Incorrect
d. hundred Incorrect

Explain the logic behind this.

3) A Wall Street investor has long exposure in US Treasury bond to the extent of $50.0 million. The investor hedges his exposure by shorting a US Treasury TIPS (treasury inflation protected security) to the extent of $44.9 million. Kindly recommend whether the hedge needs to be adjusted if the nominal yield changes by 1.0137 basis points per basis point of real yield change.
Choose one answer.
a. Buy additiona l TIPS by $ 0.62 million Incorrect
b. Sell existing TIPS by $ 0.62 million Correct
c. Sell existing TIPS by $ 4.42 million Incorrect
d. Adjustment not required

How to do this?

Thanks a ton.
 

Nicole Seaman

Director of FRM Operations
Staff member
Subscriber
Hello,

Please help me with the following questions :
What is value required to hedge a key rate exposure of $27.5 with another security with key rate exposure of $9.75, both having similar face value?
Choose one answer.
a. 35.45 Incorrect
b. 282.05 Correct
c. 37.25 Incorrect
d. 268.13 Incorrect
The correct answer is B
F = 282.05 [(27.50/ 9.75)*100]

What is the use of value 100?

2) Empirically, a nominal yield would adjust by more than ____ basis point for every basis point adjustment in real yield.
Choose one answer.
a. zero Incorrect
b. one Correct
c. ten Incorrect
d. hundred Incorrect

Explain the logic behind this.

3) A Wall Street investor has long exposure in US Treasury bond to the extent of $50.0 million. The investor hedges his exposure by shorting a US Treasury TIPS (treasury inflation protected security) to the extent of $44.9 million. Kindly recommend whether the hedge needs to be adjusted if the nominal yield changes by 1.0137 basis points per basis point of real yield change.
Choose one answer.
a. Buy additiona l TIPS by $ 0.62 million Incorrect
b. Sell existing TIPS by $ 0.62 million Correct
c. Sell existing TIPS by $ 4.42 million Incorrect
d. Adjustment not required

How to do this?

Thanks a ton.
Hello @Priyanka_Chandak23

Could you provide the source of these questions? This is helpful for anyone who can answer your questions, as they may need to reference the original source.

Thank you,

Nicole
 

Deepak Chitnis

Active Member
Subscriber
Hello,

Please help me with the following questions :
What is value required to hedge a key rate exposure of $27.5 with another security with key rate exposure of $9.75, both having similar face value?
Choose one answer.
a. 35.45 Incorrect
b. 282.05 Correct
c. 37.25 Incorrect
d. 268.13 Incorrect
The correct answer is B
F = 282.05 [(27.50/ 9.75)*100]

What is the use of value 100?

2) Empirically, a nominal yield would adjust by more than ____ basis point for every basis point adjustment in real yield.
Choose one answer.
a. zero Incorrect
b. one Correct
c. ten Incorrect
d. hundred Incorrect

Explain the logic behind this.

3) A Wall Street investor has long exposure in US Treasury bond to the extent of $50.0 million. The investor hedges his exposure by shorting a US Treasury TIPS (treasury inflation protected security) to the extent of $44.9 million. Kindly recommend whether the hedge needs to be adjusted if the nominal yield changes by 1.0137 basis points per basis point of real yield change.
Choose one answer.
a. Buy additiona l TIPS by $ 0.62 million Incorrect
b. Sell existing TIPS by $ 0.62 million Correct
c. Sell existing TIPS by $ 4.42 million Incorrect
d. Adjustment not required

How to do this?

Thanks a ton.
Answer of 3rd question should be C, because 44.9*1.0137=45.52 and 45.52-44.9=0.61513 or 0.62 simply means we have to sell additional 0.62 to hedge position completely. Hope I am right.
Thank you:)!
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
Subscriber
Hi @Priyanka_Chandak23

(1) makes no sense, can't be answered. I'm not even sure where to begin. The '100' is because key rates (KR01) are typically expressed per 100 face value, just like DV01. But they'd cancel in a ratio. So this 2.82 is the ratio of face values, or something. But really, nothing. Nevermind the assumption says face values are similar. It's a mess.

(2) Cannot be answered. Trying to refer to Tuckman's regression hedges, but we aren't told if beta is greater or less than 1.0. If (b) is true, then logically so is (a), btw. Appears to fail to understand the idea behind regression hedging.

(3) I agree with @Deepak Chitnis (but like the others, the language here is sloppy. "To the extent of" Whaattt??? :eek: Presumably they mean "face amount")
 
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Thanks a lot for your reply Deepak. I didnot consider it to be so simple, got stuck up there. However, I am not very confident about the movements in the nominal yield and real yield impact the process of hedging using futures. It would be very helpful if you could shed some light on it.

Thanks David. Could you explain what they want to imply by the second question ? Also, how would the beta <1 or >1 impact the same?

Nicole - http://www.edupristine.com/discuss/viewtopic.php?f=12&t=133781 for your reference. Came across it while browsing for some answers.

Priyanka.
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
Subscriber
@Priyanka_Chandak23 Tuckman 6.3 uses the regression equation Δy^N = α + β*Δy^R + e, which gives the nominal yield, Δy^N, as dependent on the real yield, Δy^R. So beta would give the predicted impact on nominal yield. But it's not given. And we would not assume β > 1 or whatever. We regress to discover a relationships, if any even exists. I love to debug questions, but this question is counterproductive (in my opinion) because all we are doing it trying to understand a false assumption.
 
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