Find the current bond prices

Reference no: EM132172622

Question - You are working as a bond portfolio manager and are facing the following sequence of liabilities:

Year	1	2	3
Liability	10	200	400

The current term structure of interest rates is observed (with continuous compounding):

Maturity	1	2	3
Spot rate	3%	4%	5%

Two bonds are traded: Bond A is a 3 year, 10%-coupon bond. Bond B is a 2 year, 5%-coupon bond. Both bonds have face values of 100. Note: assume annual coupon payments.

(a) Find the current bond prices.

(b) Find the duration of these two bonds and of your obligation.

(d) What is the convexity of the liability and the immunizing portfolio?

(e) What if anything can you conclude about performance of your hedged portfolio, given your numerical results above?

(f) Suppose there is a parallel shift in interest rates, up by 1%. What is the effect on your original and hedged portfolio: (i) based on the first-order approximation, (ii) based on the second-order approximation, (iii) based on the actual price impact.

Reference no: EM132172622

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