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Will the bond portfolio still be a good immunizing portfolio

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Question - You have an obligation to pay $1,000,000 in 3 years from now, and you would like to make an investment now that will enable you to meet this obligation. This investment will be a portfolio containing two of the following bonds:

Bond A: 2-year maturity coupon paying bond. The face value is $1000. Coupon rate 8% p.a. Coupons are paid at the end of each year.

Bond B: 4-year zero coupon bond. The face value is $1000.

Suppose the yield curve is flat at 8% for all maturities. Use annual compounding in this problem.

(a) What is the present value of the obligation to pay $1,000,000 in 3 years?

(b) What are the prices and durations of bond A and B?

(c) How many of bonds A and B should you buy to fully immunise your obligation?

(d) If yields rise by 1% for all maturities, by what percentage will the value of your bond portfolio change using duration approximation?

(e) Will your estimate in the previous question tend to over-state, under-state or perfectly estimate the percentage change in the bond prices? Explain why.

(f) Will the bond portfolio still be a good immunizing portfolio for your obligation after 1 year? Assume the yield curve does not change. Explain why.

Reference no: EM133019655

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