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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?
Please explain it step by step.
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