How Bond Futures Affect Interest Exposure in a Duration Hedge

Summary

The document asks how shorting bond futures to hedge a long bond’s duration affects the position’s interest income and rate exposure. It compares the intuition of retaining a fixed coupon while neutralizing duration with the possibility that the combined position behaves more like a floating-rate exposure, as in a fixed-to-floating swap. The setup assumes continuous coupon payments and a par bond whose coupon equals the risk-free rate.

The author also notes that matching the number of futures to the number of bonds would leave coupon-related duration unhedged, and asks whether a larger futures position is needed. The question describes how a rate increase might affect the long bond and short futures positions, but it supplies no derivation or answer. The net exposure depends on contract details and the hedge ratio, which the document does not specify, so it frames a fixed-income hedging problem rather than establishing a result.

Key ideas

• The question concerns the net interest exposure of a long bond hedged with short bond futures.
• It asks whether a duration hedge preserves fixed income or produces floating-rate-like exposure.
• The author distinguishes hedging principal duration from accounting for coupon duration when setting the futures position.
• The document states simplifying assumptions but provides no hedge calculation or conclusion.

Tags

# How do bond futures affect effective rate when used to hedge a bond's duration?


# How do bond futures affect effective rate when used to hedge a bond's duration?












I'm trying to wrap my head around what happens to the net interest received when an invester goes short a bond future to fully hedge the duration of his long position in an actual bond.

Does it effectively neutralize duration while still paying him a fixed rate? Or does the math work out such that he ends up effectively receiving the equivalent of a floating rate, as he would if he hedged duration with a fixed-floating swap?

Assume the following for simplicity:

- Coupons are paid out continuously, not semi-annually

- The bond is priced at par and coupon rate is the risk free rate

To be clear, he doesn't just short the same number of bond-futures as bonds he's holding because that just means he hedged the duration of the principal but not the coupons. He has to short a bit more than the number of bonds he is long by, right? So, if the rates spike up, his long bond position decreases in market value, but his short bond future position increases in market value MORE, effectively giving him gains equivalent to being long a floating rate?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.