The Zinn Company plans to issue $10,000,000 of 20 year bonds in June to help fin
ID: 2749046 • Letter: T
Question
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:
Delivery month
Open
High
Low
Settle
Change
Open Interest
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
Use the given data to create a hedge against rising interest rates.
Assume that interest rates in general increase by 200 basis points. How well did your hedge perform?
What is a perfect hedge? Are any real-world hedges perfect? Explain.
Delivery month
Open
High
Low
Settle
Change
Open Interest
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
Explanation / Answer
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: Future prices: Treasury Bonds - $100,000; Pts 32nds of 100% Delivery month Open High Low Settle Change Open interest December 94'28 95'13 94'22 95'05 +0'07 591,944 March 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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