FM16 Ch23 P06 Build a Model Solution Build a Model
Build-a-Model Solution 11/26/2018
Chapter: 23
Problem: 6
Problem Inputs:
Size of planned debt offering = $20,000,000
Value of each T-bond futures contract = 94,781.25$
Change in interest rate on debt offering (basis points) = -300
New interest rate on debt = 7.0%
Value of issuing at new rate interest = $26,406,522
Dollar value savings or cost from issuing debt at the new rate = $6,406,522
New yield on futures contract = 3.469%
New value of each futures contract $136,290
Value of all fo the futures contract at new yield = $28,757,134
Dollar change in value of the futures position = -$8,758,290
Total dollar value change of hedge = -$2,351,769
a. Create a hedge with the futures contract for F Pierce’s planned March debt offering of $20
million. What is the implied yield on the bond underlying the future’s contract?
b. Suppose interest rates fall by 300 basis points. What is the dollar savings from issuing the
debt at the new interest rate? What is the dollar change in value of the futures position? What
is the total dollar value change of the hedged position?
c. Create a graph showing the effectiveness of the hedge if the change in interest rates, in basis
points, is: -300, -200, -100, 0, 100, 200, or 300. Show the dollar cost (or savings) from issuing the
debt at the new interest rates, the dollar change in value of the futures position, and the total
dollar value change.
F. Pierce Products Inc. is financing a new manufacturing facility with the issue in March of
$20,000,000 of 20-year bonds with semiannual interest payments. It is now October, and if Pierce
were to issue the bonds now, the yield would be 10% because of Pierce’s high risk. Pierce’s CFO
is concerned that interest rates will climb even higher in coming months and is considering
hedging the bond issue. The following data are available:
Michael C. Ehrhardt Page 1 3/11/2022
Anticipated rate on debt offering = 10%
Maturity of planned debt offering = 20
Number of months until debt offering = 5
Settle price on futures contract (% of par) = 94.78125%
Maturity of bond underlying futures contract = 20
Coupon rate on bond underlying futures contract = 6%
Size of futures contract (dollars) = $100,000
FM16 Ch23 P06 Build a Model Solution Build a Model
Change in
rate
Dollar
change in
cost/savings
Dollar
change in
value of
Total dollar
value change of
hedge
Base -300 $6,406,522 -$8,758,290 -$2,351,769
-300 $6,406,522 -$8,758,290 -$2,351,769
c. Create a graph showing the effectiveness of the hedge if the change in interest rates, in basis
points, is: -300, -200, -100, 0, 100, 200, or 300. Show the dollar cost (or savings) from issuing the
debt at the new interest rates, the dollar change in value of the futures position, and the total
dollar value change.
$4,000,000
$6,000,000
$8,000,000
Effectiveness of Hedge
Michael C. Ehrhardt Page 2 3/11/2022
-200 $3,958,555 -$5,343,806 -$1,385,251
-100 $1,840,158 -$2,453,960 -$613,801