Reference no: EM131637992

Question: Invest $1, 000 in a portfolio of bonds with duration 2 using 1-year zero coupon bonds with $100 face value and 4-year bonds with $15 annual coupons and $100 face value that trade at $102. A portfolio with duration matching the investment lifetime is insensitive to small changes of interest rates. However in practice we shall have to modify the portfolio if, for example, the investment is for 3 years and one of the bonds is a zero-coupon bond expiring after one year. In addition, the duration may, as we shall see below, go off the target. As a result, it will become necessary to update the portfolio during the lifetime of the investment. This is the subject of the next subsection.