3. It is January and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capital for an expansion. Currently, TS can issue 20-year bonds with a 4% coupon (with interest paid semiannually), but TS is concerned that long-term interest rates might rise by as much as 0.5% before June. The June T-bond futures are currently trading at 19015.

a) What is the implied interest rate for the treasury bond?

b) If interest rates increase by 0.5%, what would be the futures contracts new value?

c) What would be the outcome if TS did not hedge its position?

d) What would be the outcome if TS used the T-bond futures contract to hedge its position?

4. Nero Fiddle Company and Caesar Grape Exporters face the following interest rates:

	Fixed Rate	Floating Rate
Nero	5.0%	LIBOR + 0.5%
Caesar	6.5%	LIBOR + 1.0%

Suppose that Nero borrows at the fixed-rate and Caesar borrows at the floating-rate. A financial institution arranges a swap and earns a 50-basis point spread as its fee. Nero receives 5% fixed and pays LIBOR + 0.25% to the financial institution. Caesar receives LIBOR + 1% and pays 6.25% fixed to the financial institution.

a) What are the net payments for Nero and Caesar if they engage in the swap?

b) Will Nero be better off to borrow at a floating-rate or to borrow on a fixed-rate note and engage in the swap? If so, by how much?

c) Will Caesar be better off to borrow on a fixed-rate note or to borrow at a floating-rate and engage in the swap?