Question
An investment bank agrees to underwrite $800 million, 5-year, 6 percent semiannual coupon bond issue for Amazon Inc. on a firm commitment basis. 5-year US
An investment bank agrees to underwrite $800 million, 5-year, 6 percent semiannual coupon bond issue for Amazon Inc. on a firm commitment basis. 5-year US Treasury bonds with a 2.5 percent semiannual coupon currently trade at par, and the Amazon bond is also priced to trade at par. The investment bank pays Amazon on Thursday and plans to begin a public sale on Friday. What types of interest rate movement does the investment bank fear while holding these securities? If interest rates rise 0.10 percent (10 basis points) overnight, what will be the impact on the profits of the investment bank? What if the market interest rate falls 10 basis points? How can the investment bank hedge away this risk, using the information you've been given?
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