A portfolio manager plans to use a Treasury bond futures contract to hedge a bond portfolio over the next 3 months. The portfolio is worth $100 million and will have a duration of 4.0 years in 3 months. The futures price is 122, and each futures contract is on $100,000 of bonds. The bond that is expected to be cheapest to deliver will have a duration of 9.0 years at the maturity of the futures contract. What position in futures contracts is required?
(a) What adjustments to the hedge are necessary if after 1 month the bond that is expected to be cheapest to deliver changes to one with a duration of 7 years?
(b) Suppose that all rates increase over the next 3 months, but long-term rates increase less than short-term and medium-term rates. What is the effect of this on the performance of the hedge?