A life insurance company expects to pay out cash flows on policies that it has written according
Question:
A life insurance company expects to pay out cash flows on policies that it has written according to the following schedule.
1-year $1 million
2-year $2 million
3-year $3 million
4-year $10 million
The insurance company wants to invest in some combination of 1-year and 5-year bonds such that the liability is immunized. Both bonds have a face value of $1,000 and a ytm of 4%. The 1-year bond pays a coupon of 2% and the 5-year bond pays a coupon of 6%. You may assume annual payments.
a) What should be the price of the 5-year bonds? What is the duration of the cash flows to the life insurance company?
b) The insurance company wants to invest in some combination of 1-year and 5-year bonds such that the liability is immunized. How many 1-year bonds should they buy?
Introduction To Corporate Finance
ISBN: 9781118300763
3rd Edition
Authors: Laurence Booth, Sean Cleary