Grace Hesketh is the owner of an extremely successful dress boutique in downtown Chicago. Although high fashion
Question:
Grace has been playing with the idea of trying to immunize a big chunk of her bond port-
folio. She’d like to cash out this part of her portfolio in 7 years and use the proceeds to buy a vacation home in her home state of Oregon. To do this, she intends to use the $200,000 she now has invested in the following 4 corporate bonds (she currently has $50,000 invested in each one).
1. A 12-year, 7.5% bond that’s currently priced at $895
2. A 10-year, zero-coupon bond priced at $405
3. A 10-year, 10% bond priced at $1,080
4. A 15-year, 9.25% bond priced at $980
Questions
a. Given the information provided, find the current yield and the promised yield for each bond in the portfolio. (Use annual compounding.)
b. Calculate the Macaulay and modified durations of each bond in the portfolio and indicate how the price of each bond would change if interest rates were to rise by 75 basis points. How would the price change if interest rates were to fall by 75 basis points?
c. Find the duration of the current 4-bond portfolio. Given the 7-year target that Grace has set, would you consider this an immunized portfolio? Explain.
d. How could you lengthen or shorten the duration of this portfolio? What’s the shortest portfolio duration you can achieve? What’s the longest?
e. Using 1 or more of the 4 bonds described above, is it possible to come up with a $200,000 bond portfolio that will exhibit the duration characteristics Grace is looking for? Explain.
f. Using 1 or more of the 4 bonds, put together a $200,000 immunized portfolio for Grace.
Because this portfolio will now be immunized, will Grace be able to treat it as a buy-and-hold portfolio—one she can put away and forget about? Explain.
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Related Book For
Fundamentals of Investing
ISBN: 978-0133075359
12th edition
Authors: Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk
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