3. It is January and Tennessee Sunshine is considering issuing $5 million in bon

Question

3. It is January and Tennessee Sunshine is considering issuing $5 million in bonds in June to raise capital for an expansion. Currently, TS can issue 20-year bonds with a 4% coupon (with interest paid semiannually), but TS is concerned that long-term interest rates might rise by as much as 0.5% before June. The June T-bond futures are currently trading at 190’15. a) What is the implied interest rate for the treasury bond? b) If interest rates increase by 0.5%, what would be the futures contract’s new value? c) What would be the outcome if TS did not hedge its position? d) What would be the outcome if TS used the T-bond futures contract to hedge its position?

Explanation / Answer

Answer :-

Size of Bond Issue 5,000,000

Current Interest Rate = 4%

Maturity of Debt issue 20 Years

If interest rates increased from 4 % to 4.5% ,then the value of the bonds would decrease from $ 5,000,000 to

New rate on bonds = 4.5% or 5 %

New Value of Bonds = $ PV (5 % / 2 , 20 x 2 , (5,000,000 x 4 % ) /2 , 5,000,000 , 0)

= $ 4672581

Decrease in Value of Bonds = $ 327419

So if Tennessee Sunshine waits and interest rates increase by 0.5%, they could lose half a million dollars through higher interest costs.They can hedge this cost with T - Bond Futures.

Related Questions

Navigate

• Browse (All)
• Browse 3
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.