Q. ABC Company plans to issue= $20,000,000 of 20-year bonds next June, with semi-annual interest payments. Company's present cost of debt is 10%. Though, firm's financial manager is concerned that interest rates will increase in coming months, also has decided to take short position in U. S. government t-bond futures. See settle data below for t-bond futures.
Delivery
Month Settle
(1) (5)
Dec 102-17
Mar 101-01
June 100-12
a) Compute the present value of the corporate bonds if rates increase by 2 percentage points.
b) Compute the gain or loss on the corporate bond position.
c) Compute the current value of futures position.
d) Compute the implied interest rate based on present value of futures position
e) Interest rates increase as expected, by 2 percentage points. Compute current value of futures position based on the rate calculated above plus the 2 points.
f) Compute the gain or loss on futures position.
g) Compute overall net gain or loss.
h) Is this problem the example of the each fact hedge or a cross hedge? Is it an example of speculation or hedging? Explain why?