The attached chart shows the fixed obligations of the Edison Mills pension plan, which is also managed
Question:
The attached chart shows the fixed obligations of the Edison Mills pension plan, which is also managed by the Renssalear Advisors. .
Year Benefits ($MM)
2020 $10.60
2021 $11.24
2022 $11.91
2023 $12.62
Total $46.37
Using an assumed interest rate of 6%, the present value of this stream of fixed cash outflows is $40 million. You are given $40 million to invest in U.S. Treasury bonds for the pension plan. Your boss insists that you only invest in 1 year and 10 year STRIPS. Your task is to minimize the exposure of the Edison Mills pension fund to unexpected changes in the level of interest rates. Your performance will be evaluated after one year. Assume term structure is flat at 6%.
(a) What is duration of your obligation?
(b) Describe – step by step – how you would choose and manage the portfolio of 1-year and 10- year STRIPS to minimize the exposure to interest rate risk.
Expert Answer:
A The duration of an obligation is the weighted average of the time until all cash flows from the ob... View the full answer
Financial Accounting An Integrated Statements Approach
ISBN: 978-0324312119
2nd Edition
Authors: Jonathan E. Duchac, James M. Reeve, Carl S. Warren
