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Financial Risk Management - Bond Duration, Future Contracts and Hedging

Calculate the duration of the future position, determine whether the bank should go short or long on the futures contracts, and calculate the number of contracts necessary to fully hedge the bank.

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Added on  2023-06-03

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This article discusses bond duration, future contracts and hedging in financial risk management. It explains how to calculate the duration of a bond and the number of future contracts required to hedge against interest rate changes. It also highlights the importance of hedging to ensure that the bank is fully protected against market risks.

Financial Risk Management - Bond Duration, Future Contracts and Hedging

Calculate the duration of the future position, determine whether the bank should go short or long on the futures contracts, and calculate the number of contracts necessary to fully hedge the bank.

   Added on 2023-06-03

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FINANCIAL RISK MANAGEMENT
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Financial Risk Management - Bond Duration, Future Contracts and Hedging_1
(a) Face value of bond = $ 1,000
Coupon rate = 8% p.a.
Hence, annual coupon payment = (8/100)*1000 = $ 80
The above coupon payment would be derived till the time of maturity which is 20 years.
Also, at the time of maturity, there would be principal repayment to the extent of $1,000 and
hence the cash inflows from the 1st year till the end of 19th year would be $ 80 p.a. but the
corresponding inflow for the 20th year would be $ 1080.
In order to find the duration the following table would prove to be immensely useful
(Damodaran, 2015).
On the basis of the above output, duration = 9853.829/949.999 = 10.372 years.
Financial Risk Management - Bond Duration, Future Contracts and Hedging_2

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