Reference no: EM132674762

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                          92'280                 95'130        94'220     95'050        +0'070              591,944

Mar                           96'030              96'030        95'130       92'250          +0'080                120,353

June                         95'030                95'170         95'030    95'170              +0'080              13,597

Problem a. What is the implied yield on the June futures contract? How many futures contracts will be needed to hedge potential losses in bond proceeds (based on current market conditions) due to waiting (round up to the nearest integer)? What is the total value of the hedge position?

Problem b. Assume that interest rates in general increase by 200 basis points. Suppose the bond's terms don't change and that the coupon rate is still 11%. How much would the proceeds be given the new market rates? What is the loss in proceeds based on the original target for proceeds?

Problem c. Assume that Zinn had entered the hedge found in part a. What is the new price of the hedge position? What is the gain on the hedge? What is the net effect of the loss of proceeds and the gain on the hedge?