You will design a portfolio of bonds to finance a $10 million liability for a small pension fund that must be paid within 4 years. Fund managers want to use a 2-year zero along with an 8-year zero to fund the liability. Currently, the yield curve is flat at around 5% for all maturities. 

A. Design a portfolio of bonds that will protect the pension fund from fluctuations in interest rates.

 B. Suppose the yield curve shifts to 6% across all maturities immediately after constructing the portfolio. Calculate what you expect the future value of the investment in two bonds in year 4 to be. Do you fully comply with the Fund's obligation? Explain any difference. 

C. What are the individual future values for 8-year zero and 2-year zero after a 1% increase in returns? 

D. 1% in return What are the individual present values required to finance the pension obligation for 8-year zero and 2-year zero after the increase of ? to. Are there any changes in the $10 million liability, and if so, what is it?

Answer rating: 100% (QA)

A To protect the pension fund from fluctuations in interest rates the bond portfolio should be designed in such a way that the duration of the portfol... View the full answer