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The Telex Co plans to issue $20,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is
The Telex Co plans to issue $20,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is 12% . | ||||||||||
However, the firm's financial manager is concerned that interest rates will increase in coming months | ||||||||||
And has decided to take a short position in U. S. government t-bond futures. See the settlement data below for t-bond futures. | ||||||||||
(Note: One standard future contract is $100,000) | ||||||||||
Delivery Month | Open | High | Low | Settle | Change | Open Interest | ||||
(1) | (2) | (3) | (4) | (5) | (6) | (7) | ||||
Dec | 102'13 | 102'25 | 102'15 | 102'17 | +2 | 489,777 | ||||
Mar | 102'02 | 102'25 | 101'01 | 101'01 | -5 | 105,033 | ||||
June | 101'13 | 101'15 | 100'02 | 100'30 | -1 | 15,002 | ||||
a. Calculate the present value of the corporate bonds if rates increase by 2 percentage points. | ||||||||||
b. Calculate the gain or loss on the corporate bond position. | ||||||||||
Calculate the number of futures contracts required to cover the bond position (round to the nearest whole number). Then calculate the current value of the futures position. | ||||||||||
d. Calculate the implied interest rate based on the current value of the futures position. | ||||||||||
Interest rates increase as expected, by 2 percentage points. Calculate the present value of the futures position based on the rate calculated above plus the 2 points. | ||||||||||
Calculate the gain or loss on the futures position. | ||||||||||
Calculate the overall net gain or loss. | ||||||||||
Is this problem an example of a perfect hedge or a cross hedge? Is it an example of speculation or hedging? Why? |
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