The fact that the mortgage securities were trading below par and then interest rates increased means that the mortgage securities were likely in a region where they exhibited positive convexity so negative convexity probably did not play a role. The fact that only two key rates were used is a problem. There would probably need to be at least three key rates: one for the short-term bonds, one for the long-term bonds which would cover some of the mortgage securities, and a third intermediate rate for the additional risk of the mortgage securities which do not have a bullet payment at maturity. The fact that the hedge was set up for only a 20 basis point change will mean the bonds would be poorly hedged for the indicated shifts |
