An insurance company owns a 20-year 5 percent Treasury bond. The bond has a $100,000 face value and pays its coupon semiannually. Its duration is 12.4490, current market price is $95,734 and its current yield to maturity is 5.35%. The insurance company is concerned that interest rates may increase by 85 basis points. Treasury bond futures are currently available with a price of 99. 

 

a. If interest rates rise by 85 basis points, what will be the impact on the insurance company's Treasury bond value? Support your answer with appropriate calculations. 

 

b. If the insurance company hedges its position in the Treasury bond with a Treasury future, What position should it take in the future? Why? 

 

c. Suppose interest rates rise by the expected 85 basis points and the insurance company has hedged its position as you recommend in b.

Calculate the net value of the hedge after the increase in interest rates.