Marshall Arts has just invested one million euros in BTPs (long-term Italian government bonds).

QUESTION

a. Marshall Arts has just invested one million euros in BTPs (long-term Italian government bonds). Marshall is concerned about increasing volatility in
interest rates. He decides to hedge using bond futures contracts. Should he buy or sell such contracts?

b. The treasurer of an Italian corporation plans to issue bonds in three months. She is also concerned about interest rate volatility and wants to lock in
the price at which her company could sell 5 percent coupon bonds. How would she use bond futures contracts to hedge?
Solution: a) Here since Marshall arts has invested in bonds, interest rate increase will make the investment market value go down while decrease in market rate will make the investment market value go up. WHile coupon rate of interest will remian fixon the bonds, if its a coupon paying bond. Accordingly hedging should protect should fromincreasing interest rate. Accordingly Marshall arts should sell the bond future contracts. b) Here also treasurer is concerned if interest rate in market goes up in 3 months period

n it will not fecth the price anticipated or targeted as of now. Accordingy to lock in the price so as not to loose due to lower pricing if interest rate goes up in three month period can be done with the help of hedging through bond future contracts. Accordingly treasurer should take a short position in bond future contracts for 3 months expiry.

ANSWER:

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