Money Pit Co. is short on cash due to persistent operating losses. A financing need of $6.957

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Question:

Money Pit Co. is short on cash due to persistent operating losses. A financing need of $6.957 million is predicted in the near future. While it is working with investment banks behind the scenes to drum up investor demand for a 5-year bond issuance (desired coupon rate: 7.50%; $100,000 face value), its CFO considers it prudent to lock in current interest rate levels and takes a position in the ASX 10-year bond futures (6.00% coupon; $100,000 face value). Today, the 10-year bond futures contract is quoted at 95.25 (for a price of $109,859.27). At bond issuance, the quote is 95.50. The yield on 5-year corporate bonds with comparable credit risk is initially 7.65% (for a price of $99,386.35). At bond issuance, the 5-year yield that investors demand has changed by the same amount as the yield in the futures market.

1) How many of its bonds would the company need to issue to fill its impending financing gap if the issuance were to take place today (round to a whole number)? 2) The CFO enters a (long /short) futures position for a notional value that matches the total face value of the anticipated bond issuance. He closes out that position at the time the company places its new bonds with investors.

3) What will be the nominal yield of the newly issued 5-year corporate bond of Money Pit Co.? %

4) Compute the issuance price: $

5) What is the total opportunity cost that the company incurs while waiting for the issuance to be finalized, i.e. compare the proceeds the company would have gotten earlier with the actual proceeds. Enter a cost as positive and an opportunity benefit (i.e. a situation where it was beneficial to have waited) as a negative number. $

6) Compute the price of one futures contract at the time the CFO exits the hedge positions: $

7) Compute the realized P/L of the entire hedge position (enter losses with a minus sign): $

8) Think about why the hedge P/L does not line up with the opportunity cost (or benefit) of having to wait to issue the bonds. What is supposed to happen when the hedge is perfect? And what could the CFO have done to make the hedge better?