Sorry, you lost. SPX won and implemented its proposed strategy. Now the recession of 2015 has knocked down U.S. stock prices by 20%. The value of the Madison portfolio, after paying benefits for 2015, has fallen from $90 million to $78 million. At the same time interest rates have dropped from 5% to 4% as the Federal Reserve relaxes monetary policy to combat the recession.

  

Mr. van Wie calls again, chastened by the SPX experience, and he invites a new proposal to invest the pension assets in a way that minimizes exposure to the stock market and changing interest rates. Update your memo with a new example of how to accomplish Mr. van Wie’s objectives. You can use the same portfolios and portfolio durations as in Question 1. You will have to recalculate the PV and duration of the pension benefits from 2016 onward. Assume a flat term structure with all interest rates at 4%. ( Hint: Madison’s pension obligations are now under funded. Nevertheless you can hedge interest rate risk if you increase the duration of the pension assets.)