You are a bond portfolio manager at XYZ and the investment committee has asked you to...

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Finance

You are a bond portfolio manager at XYZ and the investmentcommittee has asked you to buy a bond with price B1 and sell shorta certain quantity N of a second bond with price B2:
Bond with price B1 is a 1-year zero coupon bond with ayield-to-maturity of 1%
Bond with price B2 is a 2-year zero coupon bond with ayield-to-maturity of 2%
The resulting portfolio value is ? = B1- NB2
Questions:
1. How would you choose N to optimally hedge the interest rateexposure of the portfolio ? and thus minimize its sensitivity tointerest rate change? Find a numerical value for N
2. Using the value of N that you found in part 1), what is yourportfolio's profit or loss if both of the yield-to-maturities ofbonds B1 and B2 suddenly decrease by 1%?

Answer & Explanation Solved by verified expert

4.3 Ratings (592 Votes)

1 For zero coupon bond duration is same as year to maturity Bond B1 is a 1year zero coupon bond hence duration for bonds B1 is 1 year Similarly duration for 2 year zero See Answer

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You are a bond portfolio manager at XYZ and the investmentcommittee has asked you to buy a bond with price B1 and sell shorta certain quantity N of a second bond with price B2:Bond with price B1 is a 1-year zero coupon bond with ayield-to-maturity of 1%Bond with price B2 is a 2-year zero coupon bond with ayield-to-maturity of 2%The resulting portfolio value is ? = B1- NB2Questions:1. How would you choose N to optimally hedge the interest rateexposure of the portfolio ? and thus minimize its sensitivity tointerest rate change? Find a numerical value for N2. Using the value of N that you found in part 1), what is yourportfolio's profit or loss if both of the yield-to-maturities ofbonds B1 and B2 suddenly decrease by 1%?