Reference no: EM133276035

Please answer all these questions:

1) An company must make payments to a customer of $10 million in on year and $4 million in five years. The yield curve is flat at 10%.

a) if the company wishes to fully fund and immunize its obligation to this customer with a single issue of a zero-coupon bond, what maturity bond must it purchase?

b) what must be the face value and the market value of the zero-coupon bond?

2) Pension funds pay lifetime annuities to recipients. If a firm remains in business indefinitely, the pension obligation will resemble a perpetuity. Suppose you are managing a pension fund with obligation payment of $2 million per year to beneficiaries. The YTM on all bonds is 16%.

a) If the duration of 5-year maturity bond with coupon rate 12% (paid annually) is 4 years, and the duration of 20-year maturity bond with coupon rate of 6% (paid annually) is 11 years, how much of each coupon bonds (in market value) will you want to hold to both fully fund and immunize your obligations?

b) What will be the par value of your holdings in the 20-year coupon bond?

3. Which of the following two bonds is more price sensitive to changes in interest rates? Explain.

1) A par value bond, A, with a 12-year-to-maturity and a 12% coupon rate.

2) A zero-coupon bond, B, with a 12-year-to-maturity and a 12% yield to maturity.

4. You are managing a portfolio of $1 million. Your target duration is 10 years, and you can invest in two bonds: a zero-coupon bond with maturity of five years, and a perpetuity, each currently yielding 5%.

a. How much of (i) the zero-coupon bond and (ii) the perpetuity will you hold in the portfolio?

b. How will these fractions change NEXT YEAR if target duration is now nine years?

5. Currently, the term structure is as follows: 1-year zero-coupon bonds yield 7%; 2-year zero-coupon bonds yield 8%; 3-year zero-coupon bonds yield 9%. You are choosing between 1-, 2- and 3-year maturity bonds all paying annual coupons of 8%.

a) what is the price of each bond today?

b) what will be the price of each bond in one year if the yield curve is flat at 9% at that time?

c) what will be the rate of return on each bond?