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A question from one of my members.

Anyone have experience hedging a long municipal bond portfolio using BMA / SIFMA swaps? Anything you can share regarding sizing and structuring the swap and monitoring / adjusting it over time? How effective has this swap been in different market scenarios?

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I've added a bounty in the hopes that someone can answer this. –  chrisaycock Sep 1 '11 at 1:00
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Any update from your user? Does Akshay's answer help? –  chrisaycock Sep 3 '11 at 0:53
    
Chris I passed the answer here to my member and there is no indication if it answers all of his question. quantnet.com/forum/threads/hedging-municipal-bonds.7294 –  Andy Nguyen Sep 8 '11 at 16:22
    
Thanks for the update. I wish he had stated what he thought of the solution. I'm not qualified to assess this topic, so I just awarded the bounty for Akshay's effort. –  chrisaycock Sep 8 '11 at 17:21
    
Can someone please explain me how to mitigate basis risk in a bond portfolio with swaps against parallel shift and non-parallel shift of yield curve. –  user2629 Jul 2 '12 at 12:08
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(1) Assuming the portfolio comprises mostly senior VRDOs or comparable muni-floaters, one way of sizing a SIFMA-indexed swap would be to find the historical root-mean-square volatility of the coupon fixings of the portfolio constituents and weight them by their percentage nominal to get a proxy for the portfolio volatility.

Do the same for the SIFMA index. The ratio of the two volatilities can then be used a scaling factor for sizing the swap. (NB: This is certainly not the best way to do it, but just a useful method to get a "feel" for the swap size).

(2) With fixed-rate munis, the regular key-rate durations-based swap-hedging method should be applicable (ie calculate the dollar-duration of your portfolio with respect to rates for key tenors and then swap that fixed-rate exposure for a floating one).

(3) With subordinated debt and a collateralized swap, the credit quality of your portfolio (assuming part of it is pledged as collateral) comes into play - you might end up paying a massive fixed basis over the par swap rate which will obliterate the advantage gained by hedging the volatility of the floating rate.

(4) As far as adjustment of the swap goes: at each reset period, see if you can get a "cheaper" basis above par-swap rate if the floating-rate volatility or credit quality of your portfolio change over the reset period.

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