Reducing Bond Exposure from $100M to $50M

This interview question presents a simple fixed-income portfolio with a large, long position in a single bond and asks how to cut the economic exposure in half without directly liquidating half the bonds. The candidate must recognize that the goal is not to change the cash notional per se, but to adjust the interest rate risk so that the net exposure behaves as if the position were smaller. This type of question is common in fixed-income and macro trading, treasury, and risk management roles, especially at banks, hedge funds, and asset managers where hedging via derivatives is routine.

To answer convincingly, a candidate needs to invoke concepts like duration, dollar duration, and the use of bond futures or swaps for hedging. The interviewer is looking for clear identification of the relevant risk measure, correct proportional sizing of the offsetting derivative position, and an understanding of how long and short exposures combine. They also watch for awareness of practical details such as basis risk, maturity matching, and the difference between notional size and risk exposure.

What it tests

The core structure behind this problem class is the concept of hedging exposure using offsetting positions in derivative instruments, guided by the principle of risk equivalence. When you want to reduce or neutralize exposure to a risk factor (such as interest rate risk in bonds), you construct a position in a derivative whose price sensitivity (often measured by duration for bonds) matches the portion of risk you wish to offset. The number of contracts or size of the hedge is determined by equating the dollar duration (or other relevant risk measure) of your position to that of the hedging instrument, ensuring that changes in the underlying risk factor have the desired net effect. This approach generalizes to any asset class where derivatives exist and risk can be quantified, and it is rooted in the idea that you can synthetically alter your exposure without trading the underlying asset directly. The pattern holds because derivatives are designed to track the price movements of the underlying asset, allowing for precise risk management through proportional offsetting.