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Duration Hedging

In order to protect your project from suffering the change of interest rate, you need to hedge the risk. Hedging a risk means matching liability and assets so that you get insurance against adverse changes.

If you consider the real world scenario, perfect hedging is not possible. This is because there is no exact estimate of how much cash flow will be returned by the project. Matching all the project cash flows will be a difficult task. You will be exposed to the changes in the yield curve.

In the short horizon, duration matching works well. But, when longer horizons are concerned, you need to keep a watch on your assets and liabilities and rearrange them in order to prevent enlarging of the gap between them.

 

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