Assume you are assisting the CFO of your firm in planning an upcoming debt financing. Your firm, which is of medium-grade quality, anticipates raising $15,000,000 in funds through the issuance of fixed-rate notes. At the time of issuance, the notes will have a 10-year maturity, coupons will be paid semi-annually and set a rate so that the bonds will be priced at par, and you anticipate that the notes will have an initial yield to maturity of 150 basis points over the yield of a treasury instrument having the same maturity as your note at the time of issuance. (Because of this you can use the implied futures rate on the appropriate 10-year T-Note futures as a benchmark for this expected treasury yield.) The anticipated issuance date of the notes is sometime in this upcoming December 2022.

Due to the current uncertainty in markets, you have decided it may be prudent to hedge the interest rate risk associated with this debt financing. To not do so could
leave you with a funds shortfall if interest rates were to unexpectantly change.

A. If you were not to hedge, what is the economic impact of rates unexpectantly rising 100 basis points? In other words, compute the total present value cost to the the firm of a 100 basis point increase in rates (using present value techniques rather).

B. Describe how you would hedge the risk in this situation with futures contracts (e.g., which futures contract and its maturity, how many futures, long or short)

Answer rating: 100% (QA)

A If we were not to hedge and interest rates were to unexpectedly rise by 100 basis points then the ... View the full answer