Company has finalized plans for the disposal (sell) of one of their warehouse facility. In 6...

Company has finalized plans for the disposal (sell) of one of their warehouse facility. In 6 months, the company will receive $3 million. The Treasurer intends to invest the $3 million in Canadian Government bonds (10-year). The CFO is concerned that interest rates may decline over the next 6 months.

1) Should they buy or sell bond futures contracts, to protect against declining interest rates, and what type of hedge is this called? No calculations required. No explanation required.

2) Today, the CGB bond futures contract is valued at 131.80. Based on question 20, how many contracts should the company buy or sell? Calculations required.

3) If in 6 months time, the CGB bond futures contract is valued at 139.80 (instead of 131.80 previously) did interest rates increase or decrease? No calculations required. Briefly explain.

Refer to information provided in questions 1,2,3 Did they make a profit or loss on their futures position? Would they have done any better or worse overall financially if the CGB bond futures contract had gone down in value the same amount? No calculations required. Briefly explain.

Expert Solution

1. To protect against future investment's interest rate, the company should buy the Bond futures contracts.This fixes the price at which the company can purchase the bonds in the future. This is called as Hedging with Interest rate futures or Hedging with T-bond futures

2. No of contracts = $3 million / $131.80 per contract = 22761.76 or 22762 (rounded off)

The company should buy 22762 CGB bond future contracts

3. As the Bond Futures' price has increased in 6 months from $131.80 to $139.80 , the interest rates have decreased in the six months. This is because interest rates are inversely related to bond prices

the company made a profit as they had bought bond futures at $131.80 and now, these are at $139.80

The company would have done worse if the bond futures had declined in price , because buying the bond futures fixes the interest rates one can get in advance and one can't take advantage of favourable movements in market.

jeff jeffy answered 1 year ago

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