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.