Adjusted hedge ratio

This, however, is only part of the picture. Even though the bond held in the portfolio is the CTD, the cash market bond s behaviour relative to the notional bond described in the futures contract needs to be taken into account. The following equation illustrates how, in general, the appropriately adjusted hedge ratio can be estimated. 

Substituting the estimated BPVs into equation (16.11) provides and an adjust hedge ratio based on the relative volatility estimated to exist between the cash market bond and the futures contract. 

Questions such as the uses to which European bond futures can be put, contract specifications and trading volumes are discussed with illustrative examples. Technical issues, which surround the use of bond futures, are also examined and presented with numerical examples. The issues include the calculation of gross and net basis, identifying the cheapest-to-deliver (CTD) cash market bond, different approaches to measuring relative volatility, calculating hedge ratios, and portfolio duration adjustment. Bloomberg screen output is used to provide a real world flavour to the topics covered. 

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