hard · FRM Part 1
A Treasury bond portfolio is hedged against a parallel shift in interest rates using bond futures. However, the yield curve undergoes a 'twist' where short-term rates fall and long-term rates rise.
What is the most likely outcome?
- The hedge will be perfectly effective because duration measures sensitivity to all types of curve movements.
- The hedge will fail to perfectly protect the portfolio because it only accounted for a single, parallel shift in yields.
- The basis will immediately converge to zero, eliminating any potential loss.
- The portfolio will experience a gain because the fall in short-term rates increases the value of all bonds.
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