LOS 23.e: Formulate and evaluate an immunization strategy based on interest rate futures.
Hedging or controlling interest rate risk can involve either buying or selling derivatives, depending on the objectives. One approach is to determine a target dollar duration, compare that to the existing dollar duration, and determine the dollar duration of futures to add or subtract to reach the target. Comparing this to the dollar duration of the futures makes it easy to determine the number of contracts. This can be expressed as:
DDT = DDP + DDFuture
where: DDT = the target dollar duration of the portfolio plus futures DDP = the dollar duration of the portfolio before adding futures DDFutures = the total dollar duration of the added futures contract
Question: If the yield cure flattening (like what happen these few months), will this simple formula work? Thanks!