Problem:
Better Buy Bank has assets of $225 million and liabilities of $180 million. The asset duration is 5 years and the duration of the liabilities is 4 years. Market interest rates are 10 percent.This wishes to hedge the balance sheet with Treasury bond futures contracts, which currently have a price quote of $96.75 per $100 face value for the benchmark 20-year market yield of 6.985 percent, and duration of 13.50 years.
Required:
Question: How many contracts are necessary to fully hedge the bank if the relationship of the price sensitivity of futures contracts to the price sensitivity of underlying bonds were br = 0.95?
- 326 contracts
- 400 contracts
- 550 contracts
- 615 contracts
Note: Provide support for your underlying principle.