A financial institution issues a guaranteed investment contract for $10,000 to its customers, which has a 6-year
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A financial institution issues a guaranteed investment contract for $10,000 to its customers, which has a 6-year maturity and a guaranteed interest rate of 5% per year. The institution wants to fund the obligation using two debt instruments, which include 4-year zero-coupon bonds selling at a yield-to-maturity (YTM) of 5%, and also 5% annual coupon-paying perpetuities selling at par. Answer the following questions with steps of calculation shown:
(i) Describe an immunized portfolio for the first year such that the duration of asset portfolio is equal to the duration of the single-payment liability.
(ii) Next year, assume that YTM will remain at 5%. Describe the rebalancing strategy for the immunized portfolio.
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