Financial Risk Manager Part 1
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Global Tech has declared its intention to bring to the market a 10-year senior bond issue at par with a coupon rate of 23%, offering a spread of 1200 basis points over the corresponding 10-year Treasury issue. An investor is keen to enter into a total return swap that matures in one year with the senior bonds that are about to be issued as the reference obligation. Under the terms of the contract, payments will be exchanged semiannually, where the total return receiver will pay the six-month Treasury rate plus 328 basis points. What is the 10-year Treasury rate at the time the bonds are issued?
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Explanation:
Explanation
We know that Global Tech will be coming to market with a 10-year senior bond issue at par with a coupon rate of 23%, offering a spread of 1200 basis points over the 10-year Treasury issue.
Key calculation:
- 1200 basis points = 12%
- The bond coupon rate = Treasury rate + spread
- 23% = Treasury rate + 12%
- Treasury rate = 23% - 12% = 11%
Therefore, the 10-year Treasury yield at the time of issuance is 11%.
Note: The information about the total return swap and its terms (six-month Treasury rate plus 328 basis points) is extraneous and not needed to solve this problem. The core relationship is simply: Bond coupon rate = Treasury rate + credit spread.
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