29UIUC FIN 300%2 - UNIVERSITY OF ILLINOIS College of Business Department of Finance Finance 300(Financial Markets Professor James Jackson Risk

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UNIVERSITY OF ILLINOIS College of Business - Department of Finance - Finance 300 (Financial Markets) Professor James Jackson Risk Transfer Process: Hedgers to Speculators Coupon Bond Duration Short Hedge A bond portfolio manager (hedger) is looking to protect the firm’s cash bond portfolio from price risk due to fluctuations in market interest rates (YTM) by locking in a fixed sale price now (P t ) in order to avoid the risk of selling at lower bond market prices in the future (-P t+1 ). So, the portfolio manager initiates a short position in the U.S Treasury Bond Futures market today, while the speculator (counterparty) initiates a long position in the bond U.S Treasury Bond Futures market at P t . Thus, if the market price of the bonds in the portfolio falls in the future, money is transferred from the speculator to the bond portfolio manager that will offset the portfolio manager’s business loss equal to the difference between (-P t+1 and P t ) * # futures contracts. The number of futures contracts is determined by the
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This note was uploaded on 02/10/2011 for the course FIN 300 taught by Professor Staff during the Spring '08 term at University of Illinois, Urbana Champaign.

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