Red Buckle Inns plans to issue $85,000,000 of 20-year semi-annual bonds in January to help finance an expansion including 120 new hotels. It is now September, and the current cost of debt to the company is 9 percent. However, the firm’s financial manager is concerned that interest rates will climb by 1.5 percent in coming months. If Red Buckle hedges the bond issue, it will use treasury bond ($100,000) futures contracts that are currently trading at 99-5.
a. What is the implied annual interest rate inherent in the futures contract?
b. If interest rates increased by 1.5 percent, what would be the contract’s new value?
c. What would be the outcome (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?