Reference no: EM132466100

Pierce Products Inc. is financing a new manufacturing facility with the issue in March of $20,000,000 of 20-year bonds with semiannual interest payments. It is now October, and if Pierce were to issue the bonds now, the yield would be 10% because of Pierce's high risk. Pierce's CFO is concerned that interest rates will climb even higher in coming months and is considering hedging the bond issue.

The following data are available:

Problem Inputs: Size of planned debt offering = $20,000,000

Anticipated rate on debt offering = 10%

Maturity of planned debt offering = 20

Number of months until debt offering = 5

Settle price on futures contract (% of par) = 94.78125%

Maturity of bond underlying futures contract = 20

Coupon rate on bond underlying futures contract a 6%

Size of futures contract (dollars) = $100,000

Question a. Create a hedge with the futures contract for F Pierce's planned March debt offerin million. What is the implied yield on the bond underlying the future's contract? 9 of $20 Value of each T-bond futures contract = Number of contracts needed for hedge = rounding = Value of contracts in hedge =7 Implied semi-annual yield =7 Implied annual yield

Question b. Suppose interest rates fall by 300 basis points. What is the dollar savings from issuing the debt at the new interest rate?

Question c. What is the dollar change in value of the futures position? What is the total dollar value change of the hedged position? Change in interest rate on debt offeri ng (basis points) = -300 New interest rate on debt = Value of issuing at new rate interest = Dollar value savings or cost from iss uing debt at the new rate = New yield on futures contract = New value of each futures contract Value of all fo the futures contract at new yield = Dollar change in value of the futures position = Michael C. Ehrhardt Page 1 12/22/2016