An FI has a $100 million portfolio of six-year Eurodollar
bonds that have an 8 percent coupon. The bonds are trading at par
and have a duration of five years. The FI wishes to hedge the
portfolio with T-bond options that have a delta of –0.625. The
underlying long-term Treasury bonds for the option have a duration
of 10.1 years and trade at a market value of $96,157 per $100,000
of par value. Each put option has a premium of 3.25 (percent of
$100,000). (LG 23-4)
A) How many bond put options are necessary to hedge the bond
B) If interest rates increase 100 basis points, what is the
expected gain or loss on the put option hedge?
C) What is the expected change in market value on the bond
D) How far must interest rates move before the payoff on the
hedge will exactly offset the cost of placing the hedge?
E) How far must interest rates move before the gain on the
bond portfolio will exactly offset the cost of placing the