Question 1: The Aleander Company plans to issue $10,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is 10 percent. 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 futures contract is $100,000)
|
Delivery Month
|
Open
|
High
|
Low
|
Settle
|
Change
|
Open Interest
|
|
(1)
|
(2)
|
(3)
|
(4)
|
(5)
|
(6)
|
(7)
|
|
Dec
|
103'14
|
103'14
|
102'11
|
102'17
|
-6
|
678,000
|
|
Mar
|
102'11
|
102'23
|
100'28
|
101'01
|
-5
|
135,855
|
|
June
|
101'14
|
101'26
|
100'02
|
100'12
|
-5
|
17,255
|
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.
b. Calculate the gain or loss on the corporate bond position.
d. Calculate the implied interest rate based on the current value of the futures position.
e. 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.
f. Calculate the gain or loss on the futures position.
g. Calculate the overall net gain or loss.
h. Is this problem an example of a perfect hedge or a cross hedge? Is it an example of speculation or hedging? Why?