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I'm trying to wrap my head around what happens to the net interest received when an invester goes short a bond future to fully hedge the duration of his long position in an actual bond.

Does it effectively neutralize duration while still paying him a fixed rate? Or does the math work out such that he ends up effectively receiving the equivalent of a floating rate, as he would if he hedged duration with a fixed-floating swap?

Assume the following for simplicity:

  • Coupons are paid out continuously, not semi-annually
  • The bond is priced at par and coupon rate is the risk free rate

To be clear, he doesn't just short the same number of bond-futures as bonds he's holding because that just means he hedged the duration of the principal but not the coupons. He has to short a bit more than the number of bonds he is long by, right? So, if the rates spike up, his long bond position decreases in market value, but his short bond future position increases in market value MORE, effectively giving him gains equivalent to being long a floating rate?

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