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Question 1. An insurance company is obligated to pay $250,000 at the end of year 5 and $600,000 at the end of year 8. The company wants to immunize its position. The current interest rate is 8 percent per year.
(a) If the insurance company would like to construct the immunized position using the two below assets, how much money ought to be placed in each asset?
1. 4-year zero coupon bond selling at YTM = market interest rate.
2. 20-year 8% coupon bond selling at YTM = market interest rate.
(b) Suppose the market interest rate remains unchanged. Is the position still immunized after one year? If not, how to adjust the portfolio?
(c). Suppose the market interest rate immediately increases by 0.5% right after the portfolio is constructed. Is the position still immunized? Why?
Question 2. Risk-free zero-coupon government bonds have the following terms and market prices.
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