The Zinn Company plans to issue $10,000,000 of 20-year semi-annual bonds in June to help finance a new research and development laboratory. It is now November, and the current cost of debt to the high-risk biotech company is 11 percent. However, the firm’s financial manager is concerned that interest rates will climb by 2 percent in coming months. If Zinn hedges the bond issue, it will use a treasury bond ($100,000) futures contract with a price of 101-2 today.
a. What is the implied interest rate for the Treasury bond?
b. If interest rates increase by 2 percent, what would be the futures contract’s new value?
c. What would be the outcome if Zinn did not hedge its position?
d. What would be the outcome if Zinn hedges its position?