P23-5: The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to h

Question

P23-5: 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.

Explanation / Answer

in case of hedging long vs short vice versa.

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