Answer: The colleague's statement is incorrect because these trades are only indifferent if we scale up the reverse regression hedge.

## Explanation The colleague's statement is incorrect because simply selling $100m corporate bond to hedge a $93.6m US Treasury position is not equivalent. The key issue here relates to **hedge ratio optimization**. ### Key Points: 1. **Hedge Ratio Concept**: When hedging one asset with another, the optimal hedge ratio is determined by the correlation between the assets and their relative volatilities, not just by face value amounts. 2. **Regression Analysis**: In proper hedging, we typically use regression analysis to determine the optimal hedge ratio. The statement "these trades are only indifferent if we scale up the reverse regression hedge" suggests that the colleague's approach ignores the proper hedge ratio calculation. 3. **Risk Minimization**: Option B is incorrect because simply matching face values doesn't necessarily minimize P&L volatility. The optimal hedge minimizes variance, which requires considering the covariance structure between the assets. 4. **Risk Weights**: Option A is incorrect because risk weights would likely differ between US Treasuries and corporate bonds due to their different credit qualities and market behaviors. 5. **Face Value Decision**: Option C is partially correct but incomplete - while the hedger does decide face values, the fundamental issue is the failure to apply proper hedge ratio methodology. The correct answer is **D** because it correctly identifies that the trades are only equivalent if we properly scale the hedge using regression analysis, rather than simply matching face values.

Author: LeetQuiz .