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Hedging Interest Rates using T-bond Futures Contracts

A bank issues a $100,000 fixed-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% immediately after the mortgage is issued, what is the impact on the value of the mortgage? Assume the bank hedged the position with a short position in two 10-year T-bond futures. The original price was 64 12/32 and expired at 67 16/32 on a $100,000 face value contract. What was the gain on the futures? What is the total impact on the bank?

Solution Preview

Note: The abbreviations have the following meanings

PVIFA= Present Value Interest Factor for an Annuity

They can be read from tables or calculated using the following equations
PVIFA( n, r%)= =[1-1/(1+r%)^n]/r%

If the required rate drops to 4.0% immediately after the mortgage is issued, what is the impact on the value of the mortgage?
Step 1:
Calculate the monthly mortgage payments:

Frequency= M Monthly
No of years= 30
No of Periods= 360
Discount rate ...

Solution Summary

The solution calculates the gain on the futures contract that has been used for hedging a drop in interest rate.

$2.19