Explanation:
Duration-based hedging assumes that interest rate changes affect all maturities equally, leading to parallel shifts in the yield curve. In practice, yield curve movements are often non-parallel, such as twists or changes in curvature, which can reduce the effectiveness of the hedge. Choice A is incorrect because duration changes over time are inherent in both the portfolio and futures contracts, and the hedging process accounts for this feature. Choice B is incorrect because the conversion factor affects delivery decisions, not the duration-based hedging approach itself. Choice D is incorrect because convexity risk arises from differences in price sensitivity between the hedged asset and the futures, not directly from spot-futures price relationships.
(Book 3, Module 45.3, LO 45.i)
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Question 86
Which of the following statements best explains a limitation of duration-based hedging using Treasury bond futures? Duration-based hedging:
A
assumes that the futures contract duration remains constant over time.
B
ignores the influence of the conversion factor on the hedge’s effectiveness.
C
relies on the assumption of parallel yield curve shifts, which may not occur in practice.
D
cannot accommodate changes in the relationship between spot and futures prices, leading to convexity risk.
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