The Zinn Company plans to issue $10,000,000 of 10-year bonds in June to help finance a new research and development laboratory. It is now November, and the current cost of debt to high-risk biotech company is 11 percent. 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 High Low Open Interest
Dec. 94-28 95-13 94-22 95-05 +7 103-02 93-08 591,944
Mar. 96-03 96-03 95-13 95-25 +8 102-24 94-21 120,353
June 95-03 95-17 95-03 95-17 +8 101-02 95-02 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 you hedge perform?
c. What is a perfect hedge? Are most real-world hedges perfect? Explain?
The problem is attached on an excel spreadsheet. Also, attached is an excel toolkit that may serve as a template to solve the problem. The file that the problem is on is named Hedging23-2.
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