The treasurer of the Larson Corporation is going to bring an $8 million issue to the market in 120 days. It will be a 25-year issue. The interest rate environment is highly volatile, and even though long-term interest rates are currently 10 1⁄4 percent, there is a fear that interest rates will be up to 11 percent by the time the bonds get to the market.
a. If interest rates go up by 3⁄4 point, what is the present value of the extra interest this increase will cost the corporation? Use an 11 percent discount rate, and disregard tax considerations.
b. Assume the corporation is going to short September Treasury bonds as quoted near the top of Table 15–8 on page 404 for the CBT (Chicago Board of Trade). Based on the settle price, how many contracts must they sell to equal the $8 million exposed position? Round to the nearest whole number of contracts.
c. Based on your answer in part b, if Treasury bond prices increase by 2.8 percent of par value in each contract in response to a 1⁄2 percent decline in interest rates over the next 45 days, what will be the total loss on the futures contracts?