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We have liabilities of $50 million per year for the next 3 years, with payments made...

We have liabilities of $50 million per year for the next 3 years, with payments made at the end of the year. The term structure of interest rates is given by ?1 = ?2 = ?3 = 8%. We want to immunize these liabilities by using a 1-year zero coupon bond with face value of $1 million and a 3-year coupon bond with face value of $0.1 million, coupon rate 5%, and annual coupon payments. Assuming the bonds are correctly priced and risk-free.
(a) Show how to immunize the liabilities.
(b) Compare the convexity of the bond portfolio and the convexity of the liabilities. What can we conclude?

Solutions

Expert Solution

(a)

therefore by putting this amount in each bond we will be able to immunize our liability without any problem.

jeff jeffy answered 1 year ago
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