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Alpha Insurance Company is obligated to make payments of $2 million, $3 million, and $4 million...

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Finance

Alpha Insurance Company is obligated to make payments of $2million, $3 million, and $4 million at the end of the next threeyears, respectively. The market interest rate is 8% per annum.

i. Determine the duration of the company’s payment obligations.

ii. Suppose the company’s payment obligations are fully fundedand immunized using both 6-month zero coupon bonds andperpetuities. Determine how much of each of these bonds the companywill hold in the portfolio. (7 marks )

Answer & Explanation Solved by verified expert
3.8 Ratings (563 Votes)
1 The duration of a recurring payment or cash received is nothing but the weighted average of the time of payment which can be calculated as follows 1 2 3 4 YEAR Payment Obligation PVNominal Value1annual rateyear Share of cash flow in PV col3sumcol3 Weighted time of payment col4col1 1 2000000 1851851852 0243690456 0243690456 2 3000000 2572016461 0338458967 0676917934 3 4000000 3175328964    See Answer
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Alpha Insurance Company is obligated to make payments of $2million, $3 million, and $4 million at the end of the next threeyears, respectively. The market interest rate is 8% per annum.i. Determine the duration of the company’s payment obligations.ii. Suppose the company’s payment obligations are fully fundedand immunized using both 6-month zero coupon bonds andperpetuities. Determine how much of each of these bonds the companywill hold in the portfolio. (7 marks )

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