The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance a new research and development laboratory. The bonds will pay interest semiannually. It is now November, and the current cost of debt to the high-risk biotech company is 11%. However, the firm's financial manager is concerned that interest rates will climb even higher in coming months. The following data are available: Futures Prices: Treasury Bonds-$100,000; Pts. 32nds of 100% Delivery Month (1) Dec Mar June Low Change Open (2) High (3) (4) (6) 94'280 95'130 94'220 +0'070 96'030 96'030 95'130 95'250 +0'080 95'030 95'170 95'030 95'170 +0'080 Settle (5) 95'050 Open Interest (7) 591,944 120,353 13,597 a. What is the implied yield on the June futures contract? How many futures contracts will be needed to hedge potential losses in bond proceeds (based on current market conditions) due to waiting (round up to the nearest integer)? What is the total value of the hedge position? b. Assume that interest rates in general increase by 200 basis points. Suppose the bond's terms don't change and that the coupon rate is still 11%. How much would the proceeds be given the new market rates? What is the loss in proceeds based on the original target for proceeds? c. Assume that Zinn had entered the hedge found in part a. What is the new price of the hedge position? What is the gain on the hedge? What is the net effect of the loss of proceeds and the gain on the hedge?
The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance a new research and development laboratory. The bonds will pay interest semiannually. It is now November, and the current cost of debt to the high-risk biotech company is 11%. However, the firm's financial manager is concerned that interest rates will climb even higher in coming months. The following data are available: Futures Prices: Treasury Bonds-$100,000; Pts. 32nds of 100% Delivery Month (1) Dec Mar June Low Change Open (2) High (3) (4) (6) 94'280 95'130 94'220 +0'070 96'030 96'030 95'130 95'250 +0'080 95'030 95'170 95'030 95'170 +0'080 Settle (5) 95'050 Open Interest (7) 591,944 120,353 13,597 a. What is the implied yield on the June futures contract? How many futures contracts will be needed to hedge potential losses in bond proceeds (based on current market conditions) due to waiting (round up to the nearest integer)? What is the total value of the hedge position? b. Assume that interest rates in general increase by 200 basis points. Suppose the bond's terms don't change and that the coupon rate is still 11%. How much would the proceeds be given the new market rates? What is the loss in proceeds based on the original target for proceeds? c. Assume that Zinn had entered the hedge found in part a. What is the new price of the hedge position? What is the gain on the hedge? What is the net effect of the loss of proceeds and the gain on the hedge?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance
a new research and development laboratory. The bonds will pay interest semiannually. It
is now November, and the current cost of debt to the high-risk biotech company is 11%.
However, the firm's financial manager is concerned that interest rates will climb even
higher in coming months. The following data are available:
Futures Prices: Treasury Bonds-$100,000; Pts. 32nds of 100%
Delivery Month
Open
Low
High
(3)
Settle Change
(5) (6)
(2)
(4)
95'130 94'220
95'050
+0'070
94'280
96'030 96'030 95'130 95'250 +0'080
95'170 +0'080
95'030 95'170 95'030
(1)
Dec
Mar
June
Open Interest
(7)
591,944
120,353
13,597
a. What is the implied yield on the June futures contract? How many futures contracts
will be needed to hedge potential losses in bond proceeds (based on current market
conditions) due to waiting (round up to the nearest integer)? What is the total value
of the hedge position?
b. Assume that interest rates in general increase by 200 basis points. Suppose the
bond's terms don't change and that the coupon rate is still 11%. How much would
the proceeds be given the new market rates? What is the loss in proceeds based on
the original target for proceeds?
c. Assume that Zinn had entered the hedge found in part a. What is the new price of
the hedge position? What is the gain on the hedge? What is the net effect of the loss
of proceeds and the gain on the hedge?
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