Assume you have just been hired as a financial analyst by Tennessee Sunshine Inc. (TS), a mid-sized Tennessee company that specializes in creating exotic sauces from imported fruits and vegetables. The firm's CEO, Bill Stooksbury, recently returned from an industry corporate executive conference in San Francisco, and one of the sessions he attended was on the pressing need for companies to institute enterprise risk management programs. Because no one at Tennessee Sunshine is familiar with the basics of enterprise risk management, Stooksbury has asked you to prepare a brief report that the firm's executives could use to gain at least a cursory understanding of the topics.

To begin, you gathered some outside materials on derivatives and risk management and used these materials to draft a list of pertinent questions that need to be answered. In fact, one possible approach to the paper is to use a question-and -answer format. Now that questions have been drafted, you have to develop the answers.

1. It is January, and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capital for expansion. Currently, the firm can issue 20-year bond with a 7% coupon (with interest paid semiannually), but interest rates are on the rise and Stooksbury is considered the long-term interest rates might rise by as much as 1% before June. Online and found it June T-bond futures are trading at 111'250. What are the risks of not hedging, and how my TS hedge this exposure? In your analysis, consider what would happen if interest rates all increase by 1%.
2. What is a swap? Supposed to firms have different credit ratings. Firm Hi can borrow fixed at 11% and floating at LIBOR +1%. Firm Hi can borrow fixed at 11.4% and floating at LIBOR +1.5%. Describe a floating versus fixed interest rate swap between firms Hi and Lo in which Lo also makes a "side payment" of 45 basis points to Firm L.