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Tower Insurance must make payments to a customer of $10 million in one year and $4...

Tower Insurance must make payments to a customer of $10 million in one year and $4 million in five years. The yield curve is flat at 10%. If it wants 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? What must be the face value and market value of that zero-coupon bond?

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Expert Solution

Year

Payment

PV Factor @10% (1/(1+10%)^Year

PV                                           (Payment * PV Factor

Weight (PV/Sum of PV)

Duration (Weight *Year)

1

16

0.909

14.545

0.8541

0.8541

5

4

0.62

2.484

0.1459

0.7293

17.029

1.5835

Maturity of Zero coupon bond= 1.5835 Years

Face Value of zero coupon bond =17.209*(1+10%)^1.5835

                                                       = $ 19.803 Million

Market value of zero coupon bond =Present Value of payment= $17.029 Million

jeff jeffy answered 2 years ago
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