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Effectively Hedging The Interest Rate Risk Of Wide Floating Rate Coupon Spreads, Thomas Schröder, Kwamie Dunbar
Effectively Hedging The Interest Rate Risk Of Wide Floating Rate Coupon Spreads, Thomas Schröder, Kwamie Dunbar
WCBT Working Papers
Bond issuers frequently immunize/hedge their interest rate exposure by means of interest rate swaps (IRS). The receiving leg matches all bond cash-flows, while the pay leg requires floating rate coupon payments of form LIBOR + a spread. The goal of hedging against interest rate risk is only achieved in full if the present value of this spread is zero. Using market data we show that under a traditional IRS hedging strategy an investor could still experience significant cash flow losses given a 1% shift in the underlying benchmark yield curve.
We consider the instantaneous interest-rate risk of a bond portfolio …