You are a portfolio manager running a fixed income portfolio all of one bond. The bond is XYZ bond with a YTM of 5%, coupon 8%, term 6 years semiannual, BBB credit rating. The reinvestment rate assumption is 3%.

You have a $500M pension liability with a duration of 8 years.

Two derivative instruments available are:

• Tbond futures, priced at 97 with a duration of 3 and
• Interest rate swaps with a duration of 3.

• Calculate the bond duration.
• Calculate the # of bonds needed to fund the liability.
• Explain the conditions to immunize the portfolio using a classical duration-match immunization.
• Provide the number of Tbond contracts.
• If the reinvestment rate falls from 3% to 1%, provide the projected deficit.
• Provide the NP (notional principal of Interest Rate Swaps to hedge)
• Prove that the futures gain will > the loss attributed to the deficit.
• Prove that the IRS (interest rate swap) gain will > the loss attributed to the deficit.
• Indicate the type of swap needed.

Answer rating: 100% (QA)

Calculate the bond duration ANSWER The bond duration is 4 years CALCULATION Bond duration 4 years Pension liability duration 8 years Derivative instrument 1 Tbond futures duration 3 years Derivative i... View the full answer