A student seeks your advice for the elaboration of a hedging strategy against interest rate risk....

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A student seeks your advice for the elaboration of a hedging strategy against interest rate risk. Three years from now, the student will need to make a one-off tuition payment of £17,000 for a postgraduate course and wonders how to invest cash available today to fund that future outflow. Suppose there are two liquid bonds in the market: • Bond A: Face value = £100, current price = £85.48, no coupon payments, remaining life = 4 years Bond B: Face value = £100, current price life = 2 years £100, current price = £100, annual coupon of 4, remaining Assume all debt considered in this exercise has the same level of default risk. The benchmark yield curve for fixed-income investments of the same riskiness is flat at a level of 4% p.a. (a) Calculate the Macaulay Duration for bond A. (b) Calculate the Macaulay Duration for bond B. Explain the difference to the duration of a zero-coupon bond of the same maturity. A student seeks your advice for the elaboration of a hedging strategy against interest rate risk. Three years from now, the student will need to make a one-off tuition payment of £17,000 for a postgraduate course and wonders how to invest cash available today to fund that future outflow. Suppose there are two liquid bonds in the market: • Bond A: Face value = £100, current price = £85.48, no coupon payments, remaining life = 4 years Bond B: Face value = £100, current price life = 2 years £100, current price = £100, annual coupon of 4, remaining Assume all debt considered in this exercise has the same level of default risk. The benchmark yield curve for fixed-income investments of the same riskiness is flat at a level of 4% p.a. (a) Calculate the Macaulay Duration for bond A. (b) Calculate the Macaulay Duration for bond B. Explain the difference to the duration of a zero-coupon bond of the same maturity.

Answer rating: 100% (QA)

a We must first determine the present value of each cash flow and then weigh them according to how long to maturity they have in order to determine the Macaulay Duration for bond A We simply need to d... View the full answer