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Create a Hedge with the Futures Contract for Zinn Company

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Chapter 23. Ch 23-06 Build a Model

Problem 23-6. Use the information and data from Problem 23-5

Problem Inputs:
Size of planned debt offering = $10,000,000
Anticipated rate on debt offering = 11%
Maturity of planned debt offering = 20
Number of months until debt offering = 7
Settle price on futures contract (% of par) = 95.53125%
Maturity of bond underlying futures contract = 20
Coupon rate on bond underlying futures contract = 6%
Size of futures contract (dollars) = $100,000

a. Create a hedge with the futures contract for Zinn Company's planned June debt offering of $10 million. What is the implied yield on the bond underlying the future's contract?

Value of each T-bond future's contract =

Number of contracts needed for hedge = rounding =

Value of contracts in hedge =

Implied semi-annual yield =

Implied annual yield =

b. Suppose interest rates fall by 300 basis points. What is the dollar savings from issuing the debt at the new interest rate? What is the dollar change in value of the futures position? What is the total dollar value change of the hedged position?

Change in interest rate on debt offering (basis points) = -300

New interest rate on debt =
Value of issuing at new rate interest =
Dollar value savings or cost from issuing debt at the new rate =

New yield on futures contract =
New value of each futures contract
Value of all fo the futures contract at new yield =
Dollar change in value of the futures position =

Total dollar value change of hedge =

c. Create a graph showing the effectiveness of the hedge if the change in interest rates, in basis points, is: -300, -200, -100, 0, 100, 200, or 300. Show the dollar cost (or savings) from issuing the debt at the new interest rates, the dollar change in value of the futures position, and the total dollar value change.

Change in rate Dollar change in cost/savings of issue Dollar change in value of futures position Total dollar value change of hedge
Base -300
-300
-200
-100
0
100
200
300

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Hedging Problem

The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance a new research and development laboratory. The bonds will pay interest semiannually. It is now November, and the current cost of debt to the high-risk biotech company is 11%. However, the firm's financial manager is concerned that interest rates will climb even higher in coming months. The following data are available: Futures Prices: Treasury Bonds —$100,000; Pts. 32nds of 100%

Delivery Month Open High Low Settle Change Open Interest
(1) (2) (3) (4) (5) (6) (7)
Dec 94'28 95'13 94'22 95'05 +0'07 591,944
Mar 96'03 96'03 95'13 95'25 +0'08 120,353
June 95'03 95'17 95'03 95'17 +0'08 13,597
a. Use the given data to create a hedge against rising interest rates.
b. Assume that interest rates in general increase by 200 basis points. How well did your
hedge perform?
c. What is a perfect hedge? Are any real-world hedges perfect? Explain.

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