As per market information, Zero-Coupon Bonds of different maturities are available in the market as follows: Year Price (% of Par Value) 1 96.1538 2…

CA Final · Advanced Financial Management · MTP · November 2026
As per market information, Zero-Coupon Bonds of different maturities are available in the market as follows: Year Price (% of Par Value) 1 96.1538 2 92.4556 3 88.8996 Suppose ABC Pension Fund is holding an asset that will yield an income of ₹ 2 crore every year only for the next two years. Required: You have been engaged as consultant to prepare answers along with adequate supporting calculations of the following questions: (i) If the interest rate changes by 10 bps, estimate how much the value of asset will change in terms of ₹ lac. (ii) Suggest a hedging strategy to hedge the interest rate risk using Interest Rate Futures available at contract value of ₹ 1,00,000 and a modified duration of 5. (iii) Demonstrate how the value of total position i.e., Asset and Futures insensitive to the change in interest rate.

Suggested Answer and Working Notes:

(i) To estimate change in asset value due to change in interest rate, first we must calculate current price or value and duration of asset as follows: Year Value of Asset PVF PV (₹ Crore) PV X Year 1 ₹ 2 Crore 0.9615 1.9230 1.9230 2 ₹ 2 Crore 0.9246 1.8492 3.6984 3.7722 5.6214 Duration of Asset = 5.6214 / 3.7722 = 1.4902 The yield on Bond = (100 / 96.1538) - 1 = 0.04 i.e., 4% Accordingly, the Modified Duration of Asset = 1.4902 / (1 + 0.04) = 1.4329 Thus, the value of asset will change increases/decrease by: = 0.10% × 1.4329 × 3.7722 crore = 0.5405 Lac (ii) The No. of Interest Rate Future Contract to be short to hedge against Interest Rate risk shall be computed as follows: No of IRF = (₹ 3.7722 Crore × 1.4329) / (5 × ₹ 1,00,000) = 108.10 Since number of contracts to be rounded off to whole number the contracts of Interest Rate Futures to be short is 108 contracts. (iii) Let the yield is changed by Z percentages points. The value of Portfolio will change by: -5 × 108 × ₹ 1,00,000 × Δz + ₹ 3.7722 crore × 1.4329 × Δz = Zero (Approx.) This difference in approximation is due to rounding off number of IRF Contracts to the whole numbers.

Topics: Interest Rate Risk Management, Derivatives Analysis & Valuation

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