A portfolio manager plans to use a Treasury bond futures contract to hedge a bond portfolio over the next three months. The portfolio is worth $100 million and will have a duration of 4.0 years in three months. The futures price is 122, and each futures contract is on $100,000 face value 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.
a) What position in futures contract is required?
b) What adjustments to the hedge are necessary if after one month the bond that is expected to be cheapest to deliver changes to one with a duration of seven years?
c) Suppose that all rates increase over the three 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?