It is January and Caustic Chemicals is considering issuing $500 million in bonds in June to raise capital for an expansion. Currently, CC can issue 20-year bonds with a 4% coupon (with interest paid semiannually), but CC is concerned that long-term interest rates might rise by as much as 1% before June. The June T-bond futures are currently trading at 102-15.
a. What is the implied annual interest rate inherent in the futures contract?
b. If interest rates increased by 1 percent, what would be the contract’s new value?
c. What would be the loss (in dollars) if Red Buckle did not hedge its position?
d. What would be the outcome (in dollars) if Red Buckle used the T-bond futures to hedge its position?