Excel Online Structured Activity: Hedging

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 9%. 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	High	Low	Settle	Change	Open Interest
(1)	(2)	(3)	(4)	(5)	(6)	(7)
Dec	94'28	95'13	94'22	95'05	+0'07	591,944
Mar	96'03	96'03	95'13	95'25	+0'08	120,353
June	95'03	95'17	95'03	95'17	+0'08	13,597

The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.

1. Use the given data to create a hedge against rising interest rates. Do not round intermediate calculations. Round your answer to the nearest whole number.

   The firm must sell fill in the blank 2 contract(s) to cover the planned $10,000,000 June bond issue.

2. Assume that interest rates in general increase by 200 basis points. How well did your hedge perform? (i.e., What is the net gain or loss?) Hint: Use settlement price in your evaluations. A net loss, if any, should be indicated with a minus sign. Use the rounded number of contracts in your calculations. Do not round other intermediate calculations. Round your answer to the nearest dollar.

   On net, the firm gained (lost) $ fill in the blank 3.

3. Choose the correct description of the perfect hedge?

   _________The gains on futures contracts exactly offset losses due to lowering interest rates.The gains on futures contracts exactly offset losses due to rising interest rates.The gains on futures contracts exactly offset gains due to rising interest rates.The losses on futures contracts exactly offset losses due to rising interest rates.

   Are any real-world hedges perfect?

   _____No.Yes.

Hedging Value of bond issue next June Maturity of bond issue, in years Frequency of interest paid in year Current annual interest (cost of debt), November Expected increase in interest rate in basis points Increase in annual interest rate in percentage Maturity of hypothetical bond in futures contract Annual coupon rate of hypothetical bond in futures contrac $10,000,000 20 2 9.00% 200 2.00% 20 6.00% Futures Prices: Treasury Bonds Delivery Month (1) Dec Mar June $100,000 Open (2) 94'28 96'03 95'03 High (3) 95'13 96'03 95'17 Pts. 32nds of 100% Low (4) 94'22 95'13 95'03 Settle (5) 95'05 95'25 95'17 Change (6) +0'07 +0'08 +0'08 Interest (7) 591,944 120,353 13,597 To protect from rising interest rates, firm must sell futures contracts Whole percentage of quote 32nds of 100% of quote 95 17 Value of 1 futures contract Number of futures contracts to sell to the nearest whole) Total value of futures contracts Formulas #N/A #N/A #N/A Determination of how well hedge performed Value of bond issue at increased interest rate Loss on bond issue #N/A #N/A Implied yield at time futures contract entered Yield with increase in interest rates #N/A #N/A Value of 1 futures contract Total value of futures contracts #N/A #N/A Profit on futures contracts, ignoring commissions #N/A Net profit #N/A Hedging Value of bond issue next June Maturity of bond issue, in years Frequency of interest paid in year Current annual interest (cost of debt), November Expected increase in interest rate in basis points Increase in annual interest rate in percentage Maturity of hypothetical bond in futures contract Annual coupon rate of hypothetical bond in futures contrac $10,000,000 20 2 9.00% 200 2.00% 20 6.00% Futures Prices: Treasury Bonds Delivery Month (1) Dec Mar June $100,000 Open (2) 94'28 96'03 95'03 High (3) 95'13 96'03 95'17 Pts. 32nds of 100% Low (4) 94'22 95'13 95'03 Settle (5) 95'05 95'25 95'17 Change (6) +0'07 +0'08 +0'08 Interest (7) 591,944 120,353 13,597 To protect from rising interest rates, firm must sell futures contracts Whole percentage of quote 32nds of 100% of quote 95 17 Value of 1 futures contract Number of futures contracts to sell to the nearest whole) Total value of futures contracts Formulas #N/A #N/A #N/A Determination of how well hedge performed Value of bond issue at increased interest rate Loss on bond issue #N/A #N/A Implied yield at time futures contract entered Yield with increase in interest rates #N/A #N/A Value of 1 futures contract Total value of futures contracts #N/A #N/A Profit on futures contracts, ignoring commissions #N/A Net profit #N/A