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Return from Hedged Position

Mike Lane will have $5 million to invest in five -year U.S. Treasury bonds three months from now. Lane believes interest rates will fall during the next three months and wants to take advantage of prevailing interest rates by hedging against a decline in interest rates. Lane has sufficient bonds to pay the costs of entering into and maintaining a futures position.
a. Describe what action Lane should take using five-year U.S. Treasury note futures contracts to Assume three months have gone by and, despite Lane's expectations, five-year cash and forward market interest rates have increased by 100 basis points compared with the five-year forward market interest rates of three months ago.
b. Discuss the effect of higher interest rates on the value of the futures position that Lane entered into part a.
c. Discuss how the return from Lane's hedged position differs from the return he could now earn if he had not hedged in part a.

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Below are my answers.

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Anna Liza Gaspar

ANSWERS

Discussion Question a
To hedge against a decline in interest rates, Mike Lane needs to take a long position in a three-month interest rate futures contract with a $5 five-year U.S. Treasury bond as an underlying.
Assuming that three months have gone by and that the ...

Solution Summary

This solution of 254 words discusses different scenarios using the U.S. Treasury bonds such as future contraction, higher interest rates and the return from a hedged position.

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