Tree Row Bank has assets of $ million, liabilities of $ million, and equity of $ million. The asset duration is six years and the duration of the liabilities is four years. Market interest rates are percent. Tree Row Bank wishes to hedge the balance sheet
with Treasury bond futures contracts, which currently have a price quote of $ per $ face value for the benchmark year, percent coupon bond underlying the contract, a market yield of percent, and a duration of years.
a Should the bank go short or long on the futures contracts to establish the correct macrohedge?
b How many contracts are necessary to fully hedge the bank?
c Verify that the change in the futures position will offset the change in the cash balance sheet position for a change in market interest rates of plus basis points and minus basis points.
d If the bank had hedged with Treasury bill futures contracts that had a market value of $ per $ of face value and a duration of year, how many futures contracts would have been necessary to fully hedge the balance sheet?
e What additional issues should be considered by the bank in choosing between bond or bill futures contracts?
