What is the cost of financing liability by holding

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Financial institutions must have the assets available to cover liabilities when they arise. Many types of liabilities are known in advance. It is therefore possible to set up investments, like bonds, so that the inflow of cash from the bonds will match the outflow needed to cover the liabilities due at each point in time. This strategy is called "duration matching" or "immunization."

Problem (a) A company has a $20,000 liability (payment to be made) due at the end of year 2. It can purchase 2-year zero coupon bonds at 9% spot rate. What is the cost of financing your liability by holding the 2-year bond that would pay $20,000?

Reference no: EM132964457

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