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Long Forward Hedge

You are planning to enter into a long forward hedge to offset a short forward position. If you choose a futures contract over a forward contract, which of the following circumstances do you want?

a. Do you want the term structure of interest rates (example...the plot of interest rates against maturities) to be sloped up or down?? and why

b. DO you want the volatility of interest rates to be increasing or decreasing? and why

c. Do you want the volatility of the futures price change to be hugher or lower than the forward price? and why

d. Do you want the correlation of the spot to futures to be higher or lower than that of the spot to forwards? and why

please discuss in detail

Solution Preview

a. Since the futures use the inverse relationship between bond price and interest rate, you will want the term structure of interest rate against maturities to be sloped down up if you want to enter a long forward position now. When the interest rate is decreasing, the future price is increasing, and vice versa. Therefore, you will want to buy now at lower price, and sell later at higher price in the future (at low interest rate) in order to make a gain/profit.

b. It really depends if the ...

Solution Summary

Long forward hedging are examined. The term structure of interest rates are given.

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