Question

In: Economics

One strategy that is used to hedge interest rate risk is to match the modified duration...

One strategy that is used to hedge interest rate risk is to match the modified duration of assets and liabilities. If we hedge the above bond in question 7 with a zero coupon bond, what would be the maturity of said zero.

Solutions

Expert Solution

Par Value =100
Semi annual Coupon =3
Number of Periods =3*2 =6
Price =98.50
semi annual Rate using financial calculator
N=6;PMT=3;PV=-98.50;FV=100;CPT I/Y =3.279466%
Rate =3.279466%
Macaulay Duration =(1*Coupon1/(1+r)+2*Coupon 2/(1+r)^2+3*Coupon 3/(1+r)^3+4*Coupon 4/(1+r)^4+5*Coupon 5/(1+r)^5+
6*(Coupon 6+Par Value)/(1+r)^6)/Price
=(3/(1+3.279466%)+3*2/(1+3.279466%)^2+3*3/(1+3.279466%)^3+3*4/(1+3.279466%)^4+3*5/(1+3.279466%)^5+103*6/(1+3.279466%)^6/98.50 =5.5759
Macaulay Duration =5.5759/2 =2.79

Modified Duration =Macaulay Duration/(1+YTM/2) =(5.5759/2)/(1+3.279466%/2) =2.74


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