How do I set up a key rate duration hedge for a bond portfolio?

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AcadiFi · Accepted Answer

Key rate duration (KRD) decomposes interest rate sensitivity across specific points on the yield curve. Standard points: 2, 5, 10, 20, 30 years. KRD at a point measures portfolio price change for a 100 bp shift at that point with other points held fixed. ```mermaid flowchart LR A[Portfolio
Duration 7.2] --> B[KRD
Decomposition] B --> C[2Y
KRD 0.8] B --> D[5Y
KRD 2.1] B --> E[10Y
KRD 3.2] B --> F[30Y
KRD 1.1] ``` For Stonegate Fixed Income $800M portfolio with KRDs 2Y=0.8, 5Y=2.1, 10Y=3.2, 20Y=0.9, 30Y=1.1 (sum = 8.1, close to total duration 7.2 with rounding and convexity terms). Hedge setup. For each point, determine Treasury futures contract with matching cheapest-to-deliver duration. 2-year note futures (ZT): duration ~1.9, notional $200k per contract, DV01 ≈ $38. 5-year (ZF): duration ~4.5, $100k, DV01 ≈ $45. 10-year (ZN): duration ~7.5, $100k, DV01 ≈ $75. Ultra-long (UB): duration ~18, $100k, DV01 ≈ $180. Compute portfolio DV01 at each KRD. Portfolio 10Y DV01 = $800M × 3.2% × 0.01 = $256k per 100 bp, or $2,560 per bp. Number of ZN futures to hedge 10Y KRD = $2,560 / $75 ≈ 34 contracts short. Repeat for each point. Sizing summary. 2Y: short ~17 ZT. 5Y: short ~47 ZF. 10Y: short ~34 ZN. 30Y: short ~6 UB. Post margin, monitor daily mark-to-market, rebalance monthly or after 25 bp moves at any point. KRD hedging neutralizes curve risk but preserves spread duration; credit spread moves still affect portfolio. For more precise hedging, use principal component analysis on the yield curve to identify level/slope/curvature factors and hedge those.

How do I set up a key rate duration hedge for a bond portfolio?

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