What rate will Hiratani lock in by initiating this hedge and does this hedging strategy eliminate Southeast's exposure?

On January 6, 1984, Lori Hiratani, treasurer of the Southeast Corporation, reviewed a financial analysis of a plan to build an automated manufacturing facility near Southeast's Atlanta headquarters. Southeast Corporation's management committee had approved construction of the facility late in 1983, and had authorized the issuance of $60 million in long-term debt to finance the project. Although Hiratani considered current borrowing rates to be particularly attractive, she planned to defer issuance of additional debt until the new facility had been completed in August 1984. She believed that completion of the project would improve the company's credit rating, enabling Southeast to secure a Aa rating on the planned $60 million debt issue. Despite the potential for improvement in the quality of its credit, Hiratani realized that Southeast's total borrowing costs could increase substantially from the current 12.88% Aa rate if long-term interest rates moved against her over the succeeding seven months. In order to lock in the attractive current borrowing rates, Hiratani decided to hedge her August 1984 debt issue by selling short Treasury bond futures contracts. On January 6, September 1984 T-bond futures prices were quoted at 69-08. Hiratani had determined that this price reflected delivery of the 12% coupon Treasury bond maturing August 1, 2013. This "cheapest-to-deliver" bond was callable after August 1, 2008, and was priced in the cash market at 101-18 (an 11.80% yield). Hiratani estimated the duration of this T-bond at 8.5 years. The $60 million Southeast debt offering, scheduled to be issued the first week in August, was to carry a maturity of 25 years and sinking fund provisions requiring retirement of 10% of the issue each year beginning in year 20. Assuming the bonds were issued at current coupon levels, the duration of this obligation would equal 7.8 years. As she planned her hedge, Hiratani reviewed a variety of data concerning historical movements in the prices and yields of long Treasury and Aa corporate bonds (see Exhibits 1 and 2). 1. How many September 1984 T-bond futures contracts should Lori Hiratani sell short to hedge Southeast's interest rate exposure? 1983 Interest Rates T-Bonds vs. Ad Corporates 13 12.8 12.6 Wh 12.4 12.2 12 11.8 Rate (%) tegh 11.6 11.4 11.2 11 10.8 10.6 10.4 J F M A MJ J JA A S O N D 1983 + Ad New Industrials T-Bonds On January 6, 1984, Lori Hiratani, treasurer of the Southeast Corporation, reviewed a financial analysis of a plan to build an automated manufacturing facility near Southeast's Atlanta headquarters. Southeast Corporation's management committee had approved construction of the facility late in 1983, and had authorized the issuance of $60 million in long-term debt to finance the project. Although Hiratani considered current borrowing rates to be particularly attractive, she planned to defer issuance of additional debt until the new facility had been completed in August 1984. She believed that completion of the project would improve the company's credit rating, enabling Southeast to secure a Aa rating on the planned $60 million debt issue. Despite the potential for improvement in the quality of its credit, Hiratani realized that Southeast's total borrowing costs could increase substantially from the current 12.88% Aa rate if long-term interest rates moved against her over the succeeding seven months. In order to lock in the attractive current borrowing rates, Hiratani decided to hedge her August 1984 debt issue by selling short Treasury bond futures contracts. On January 6, September 1984 T-bond futures prices were quoted at 69-08. Hiratani had determined that this price reflected delivery of the 12% coupon Treasury bond maturing August 1, 2013. This "cheapest-to-deliver" bond was callable after August 1, 2008, and was priced in the cash market at 101-18 (an 11.80% yield). Hiratani estimated the duration of this T-bond at 8.5 years. The $60 million Southeast debt offering, scheduled to be issued the first week in August, was to carry a maturity of 25 years and sinking fund provisions requiring retirement of 10% of the issue each year beginning in year 20. Assuming the bonds were issued at current coupon levels, the duration of this obligation would equal 7.8 years. As she planned her hedge, Hiratani reviewed a variety of data concerning historical movements in the prices and yields of long Treasury and Aa corporate bonds (see Exhibits 1 and 2). 1. How many September 1984 T-bond futures contracts should Lori Hiratani sell short to hedge Southeast's interest rate exposure? 1983 Interest Rates T-Bonds vs. Ad Corporates 13 12.8 12.6 Wh 12.4 12.2 12 11.8 Rate (%) tegh 11.6 11.4 11.2 11 10.8 10.6 10.4 J F M A MJ J JA A S O N D 1983 + Ad New Industrials T-Bonds