Question

QUESTION 121

1. A bank owns a portfolio of Treasury bonds but wants to hedge its position. Which of the following would make the most sense?

   		a. Buy call options on Treasury bonds.
   		b. Buy futures contracts on Treasury bonds.
   		c. Sell futures contracts on Treasury bonds.
   		d. Sell put options on Treasury bonds.

QUESTION 122

1. What is the primary risk to investors when hedging with futures contracts?

   		a. Basis fluctuations.
   		b. Futures prices may increase.
   		c. Futures prices may decrease.
   		d. Insufficient funds to meet margin requirements and maintain the futures position.

Answer 1

Answer 121 :

Option C - Sell future contracts on treasury bonds

As the bank owns the portfolio of treasury bonds, it means that the bank has bought and is long in them. So the downside risk of this investment is when the bond prices go down. In order to hedge this downside risk, the bank will take a contradictory position i.e. sell the futures contract on treasury bonds. Buying Call options or call futures or selling put options are all bullish strategies which wont hedge this portfolio.

Answer 122:

Option A - Basis fluctuations

When we hedge a position with a futures contract, the biggest risk is the basis fluctuations which means the spread between the future price and spot price may widen or narrow down. During hedging, the biggest fear of the trader is that the future should move in a steady correlation with the spot price and not in an erratic manner. This option is most relevant as compared to other options given.