1. 30-year maturity bond has a 7.8% coupon rate, paid annually. It sells today for $882.6. A 20-year maturity bond has a 7.3% coupon rate, also paid annually. It sells today for $896.7. A bond market analyst forecasts that in five years, 25-year maturity bonds will sell at yields to maturity of 8.8% and 15-year maturity bonds will sell at yields of 8.3%. Because the yield curve is upward sloping, the analyst believes that coupons will be invested in short-term securities at a rate of 6.5%.

a. Calculate the (annualized) expected rate of return of the 30-year bond over the 5-year period.

b.What is the (annualized) expected return of the 20-year bond?

2. You are managing a portfolio of $1 million. Your target duration is 10 years, and you can invest in two bonds, a zero-coupon bond with maturity of five years and a perpetuity, each currently yielding 7.5%.

a. What weight of each bond will you hold to immunize your portfolio? (Round your answers to 2 decimal places.)

zero coupon bond

perpetuity bond

b. How will these weights change next year if target duration is now nine years? (Round your answers to 2 decimal places.)

zero coupon bond

perpetuity bond

3. A 30-year maturity bond has a 7.8% coupon rate, paid annually. It sells today for $882.6. A 20-year maturity bond has a 7.3% coupon rate, also paid annually. It sells today for $896.7. A bond market analyst forecasts that in five years, 25-year maturity bonds will sell at yields to maturity of 8.8% and 15-year maturity bonds will sell at yields of 8.3%. Because the yield curve is upward sloping, the analyst believes that coupons will be invested in short-term securities at a rate of 6.5%.

a. Calculate the (annualized) expected rate of return of the 30-year bond over the 5-year period. (Round your answer to 2 decimal places.)

b. What is the (annualized) expected return of the 20-year bond? (Round your answer to 2 decimal places.)