INTECH Corporation: Hedge Ratio Case

INTECH Corporation is a high-grade (AAA) rated firm. The company plans to issue $800 million (face value) in bonds in mid-March 2000. Each bond will have a par value of $1,000, with a coupon rate of seven-percent paid annually, and a maturity of 25 years from the March 2000 issue date. The company plans to price the bonds to yield 11 percent. The first question to be answered concerns what price the company expects to receive for the bonds when they are issued in March 2000. This price is determined as follows:

Bond Value = $1,000(PVIF11%, 25 years) + $70(PVIFA11%, 25 years)

= $1,000(.074) + $70(8.422)

The required return on the bond is higher than the coupon rate of the bond. For this reason, the bond must be sold at a discount. The second question to be answered concerns what risk the company faces between mid-November 1999 and the planned issue date of mid-March 2000 in relation to the yield on the planned bond issue. With approximately 120 days between the current data and the planned issue date in mid-March 2000, the company risks market interest rate changes that may cause the require discount on the bond to be higher than planned. Should this potential materialize, the company would be required to issue more than $800 million (face value) in bonds to realize the planned level of net proceeds from the bond issue.

A futures contract for United States Treasury bonds f

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