Interest rate implied by spot and futures prices of bonds

Assignment Help Financial Management

Reference no: EM132033944

Prices of bond futures can be used to access the markets expectations about future interest rates and therefore can be used as the basis for pricing other financial securities. A 10-year annual coupon bond with face value $1,000 is currently selling for $919. The futures price of this bond for delivery in 1 year is $888. The bond pays coupon of $88 annually. Assume that the coupon is paid before the delivery of the bond.

(a) What is the 1-year interest rate implied by the spot and futures prices of bonds? (Hint: Recall the PV formula of bond prices for a one-year horizon.)

(b) In the gold futures market, the spot price of gold is $1337 per ounce. There is no storage cost. What is the futures price per ounce of gold for delivery in one year? Suppose there is no uncertainty in interest rates.

(c) Suppose your friend Emily has also longed a forward contract on gold for delivery one year from now. But the contract was entered last year. The forward price she locked in was $1375. Clearly her contract is valuable now because the gold price has risen since last year, and no one is able to lock in such a low price now. What is the maximum amount you would pay now for having her contract? Does it violate the proposition that forward and futures contracts should have zero value at the time of initiation? Explain.

(d) A jewelry producer just received an order that is worth $1 million from a department store for gold necklaces to be delivered in 6 months. The producer will be paid in 6 months. He cant buy gold now because he cant afford the storage cost. Suppose the gold necklaces can be produced instantaneously. What is the risk of the producer? What hedging strategy would you recommend to him? Explain briefly why the strategy would work.

Reference no: EM132033944

Questions Cloud

The interest rate on the loan with the compensating balance : How low would the interest rate on the loan with the compensating balance have to be for you to choose it?

Make each year to break even on the cost of the hoe : How much did “We Dig It” have to make each year to break even on the cost of the hoe?

How much would the company afn be reduced : Sales are expected to grow by 14% next year and the CFO wants to lower the DSO to the industry average of 42 days.

Withdraw from the fund to purchase car : how much did John’s parents allow him to withdraw from the fund to purchase his car?

Interest rate implied by spot and futures prices of bonds : What is the 1-year interest rate implied by the spot and futures prices of bonds? What hedging strategy would you recommend to him?

What should management do to recuse the cost of capital : What should management do to recuse the cost of capital? Why would that be successful?

Statements is true about the efficient market hypothesis : Which of the following statements is true about the efficient market hypothesis?

Net income to the controlling and noncontrolling interests : determine the proper allocation of consolidated net income to the controlling and noncontrolling interests?

Sensitivity of the npv to changes in the price of new clubs : McGilla Golf has decided to sell a new line of golf clubs. What is the sensitivity of the NPV to changes in the price of the new clubs?

User Account

All Pages