Hedging bond issue

The Eurozone IL swap market started trading in May 2001, months before the Tresor issued the first Eurozone IL bond, the OATei 2012. The introduction and hedging of retail inflation protected equity products (e.g., those issued by the Italian Post Office and others) helped to kick off activity in the interbank Eurozone IL swap market, which has seen a steadily increasing uptrend in volumes traded per month. As of May 2003, pension related IL swaps and swaps from corporate payers are still a rarity, however some infrastructure driven hedging is taking place. 

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. 

An off-market swap is one whose fixed rate is different from the market swap rate. To compensate for this difference, one counterparty pays the other a sum of money. An off-market rate may be required for a particular hedge, or by a bond issuer that wants to cover the issue costs as well as hedge the loan. 

A hedge is a position in a cash or off-balance-sheet instrument that removes the market risk exposure of another position. For example, a long position in 10-year bonds can be hedged with a short position in 20-year issues or with futures contracts. The concept is straightforward. Implementing it effectively, however, requires a precise calculation of the amount of the hedge needed, and that can be complex. 

Year-on-year inflation swap. This swap is commonly used to hedge issues of IL bonds. The swap is composed of ... 

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