dy 2 dy 2 dp 1 d 2p p y dy p y dy dy 2 dy 2

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Unformatted text preview: llar duration, dY Fixed Income II: R. J. Hawkins d 2P ≡ Dollar convexity dY 2 Econ 136: Financial Economics 5/ 19 Duration Hedging: Let’s hedge one bond with another. We define a bond hedge to be a bond portfolio that doesn’t change in value when the yield changes. The P&L of the portfolio: Let Qi be the quantity of bond i . Let dPi be the price change of bond i . Then the profit and loss or P&L of the portfolio is: P&L = Q1 dP1 + Q2 dP2 Fixed Income II: R. J. Hawkins Econ 136: Financial Economics 7/ 19 Duration Hedging: To determine the hedge set the P&L to zero: The the P&L of the portfolio is P&L = −dY Q1 D$1 + Q2 D$2 = 0 Clearing dY and solving for Q2 : Q2 = − D$1 Q1 D$2 If the original position is long then the hedge is short. If the original position is short then the hedge is long. Fixed Income II: R. J. Hawkins Econ 136: Financial Economics 10/ 19 The Perfect Hedge: Background We know that bonds with fixed coupons have a finite duration. Bonds with floating-rate coupons have a duration of zero. What h...
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This note was uploaded on 01/23/2014 for the course ECON 136 taught by Professor Szeidl during the Fall '08 term at University of California, Berkeley.

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