Question: (a) Suppose that the current term structure is at and all spot rates are equal to 10% per annum. A bond portfolio manager is considering

(a) Suppose that the current term structure is at and all spot rates are equal to 10% per annum. A bond portfolio manager is considering how to protect a short positionF which is equivalent to shortselling,r a 5year zerocoupon bond with a face value of $5 million. Suppose that he can only trade 2year and 10Lyear zerocoupon bonds, both with the face value of $1,000. (Assume he can trade these bonds by any amount without transaction cost.) What should he do so that the overall portfolio of the 2year and 10year bonds plus the short position has duration of 0? (b) If the term structure is slightly steepened such that the 2year spot rate decreases by 0.01%, the 5year spot rate remains the same, and the 10year spot rate increases by 0.01%. How does the value of the overall portfolio from (a) change? You may use approximations by duration

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