Explain classical immunization strategy

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You are managing a $120 million portfolio of fixed-income securities for the Echidna Endowment Fund. The fund aims to provide a return of 4% per annum and has a large liability due in 6-years. The current duration of the portfolio is 6.2 years.

Explain how you would use a classical immunization strategy to manage your portfolio in light of the large liability.

Expecting an increase in interest rates in the short term, you decide to reduce the duration of the fund to 5.0. You use a futures contract with a notional value of $100,000, a duration of 4.8, and a conversion factor of 0.85. How many futures contracts do you need to buy or sell to achieve the desired duration?

You decide to use leverage to increase the return on the portfolio. You borrow an additional $80 million at 3% interest. All of your funds are then invested to earn a 5% return. How much does this increase your return on equity? What is the potential drawback of using greater leverage?

Reference no: EM132908422

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