You need to create an investment in government bonds to fund a liability of 15 million due
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Question:
You need to create an investment in government bonds to fund a liability of £15 million due for payment in nine years’ time. The following UK government bonds are available.
Term to Maturity | Annual Coupon Rate | Annual Yield to Maturity |
7 years | 1.30% | 1.88% |
9 years | 2.10% | 1.88% |
11 years | 3.40% | 1.88% |
Coupons are semi-annual and paid on the same day for all three bonds. Assume the next coupon payments occur in six months’ time and that bond par values are £100.
Required
- Calculate the market prices of the three bonds.
- Calculate the modified duration of each bond
- Adopt a liability funding strategy comprising an investment in the bond whose term to maturity coincides with the term of the liability. Assess how well the funding approach works if the annual yield immediately falls by one half of percentage point (0.5%) and thereafter remains constant.
- Create a two-bond investment based on an immunisation approach to funding the liability and show effectively the strategy works if the yield immediately falls by one percentage point and subsequently remains constant
- Briefly discuss the reason for the difference between the income generated by the immunisation strategy and the amount needed to fund the liability.
Related Book For
Systems Analysis and Design
ISBN: 978-1285171340
10th edition
Authors: Shelly Cashman, Harry J. Rosenblatt
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