Kiakaha

btw, you didn’t have to do calcs to determine the % of each bond you need to sell in order to hedge….i think hedge effectiveness is fair game.

Kiakaha

spud, in question number one he is using a sole treasury futures contract to hedge.
in the last question of the item set, they show a duration hedge and a two bond hedge. to correctly hedge the GNMA and account for the negative convexity you need to use the two bond hedge.
If you use the two bond hedge while holding the GNMA, you’ll notice that the difference between the two is -.074. This is essentially your cost of performing the hedge. You earn a spread of 168 basis points on the GNMA annually or 168/12 = 14 bps per month and therefore you are able to cover the costs of the hedge.
Make sense?