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Suppose that a pension fund has to make a payment of $1 million in 2 years...

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Finance

Suppose that a pension fund has to make a payment of $1 millionin 2 years time. It can hold a one year pure discount bond thatwill pay $1000 in 1 year; or a 3 year bond that will pay a couponof $100 each year, will be redeemed for $1,000 at the end of thethird year. The yield on each bond is 15%. (a) What is the price ofeach bond? (b) What is the duration of each bond. (c) How much ofeach bond should the fund hold to immunize itself against interestrate risk? Explain.

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4.1 Ratings (710 Votes)
a Yield y 15Price of one year pure discount bond that will pay 1000 in 1year P1 1000 1 y 1000 1 15 86957Price of a n 3 year bond that will pay a coupon of C 100each year will be redeemed for FV P3 1000 at theend    See Answer
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Transcribed Image Text

Suppose that a pension fund has to make a payment of $1 millionin 2 years time. It can hold a one year pure discount bond thatwill pay $1000 in 1 year; or a 3 year bond that will pay a couponof $100 each year, will be redeemed for $1,000 at the end of thethird year. The yield on each bond is 15%. (a) What is the price ofeach bond? (b) What is the duration of each bond. (c) How much ofeach bond should the fund hold to immunize itself against interestrate risk? Explain.

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