What is duration of the cash flows to life insurance

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Reference no: EM133630017

A life insurance company expects to pay out cash flows on policies that it has written according to the following schedule.

Year Payment

1 $1 million

2 $2 million

3 $3 million

4 $10 million

The insurance company wants to invest in some combination of 1-year and 5-year bonds such that the liability is immunized. Both bonds have a face value of $1,000 and a ytm of 4%. The 1-year bond pays a coupon of 2% and the 5-year bond pays a coupon of 6%. You may assume annual payments. Use 4% as the discount rate throughout this problem.

1. What is the duration of the cash flows to the life insurance company?

2. What should be the price of the 5-year bonds?

3. The insurance company wants to invest in some combination of 1-year and 5-year bonds such that the liability is immunized. How many 1-year bonds should they buy?

Reference no: EM133630017

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