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11. A financial institution accepts an $85,000 deposit from a customer on which it guarantees to pay 8% compounded annually for ten years. The only
11. A financial institution accepts an $85,000 deposit from a customer on which it guarantees to pay 8% compounded annually for ten years. The only investments available to the institution are five-year zero coupon bonds and preferred stocks with a fixed dividend rate of 8%, both yielding 8%. The institution develops an investment policy using the following reasoning: (i) The duration of the five-year zero coupon bonds is 5. (ii) The duration of the preferred stock is 13.5. (iii) The duration of the obligation to the customer is 10. (iv) Taking the weighted average of the durations, the amount invested in five-year zero coupon bonds is chosen to be 13.5 - 10 * (85,000) = $35,000 13.5 - 5 while the amount invested in preferred stock is chosen to be 10 - 5 13.5 5 * (85,000) $50,000 Verify that this investment strategy is optimal under immunization theory, assuming the customer leaves the funds on deposit for the full ten-year period. 11. A financial institution accepts an $85,000 deposit from a customer on which it guarantees to pay 8% compounded annually for ten years. The only investments available to the institution are five-year zero coupon bonds and preferred stocks with a fixed dividend rate of 8%, both yielding 8%. The institution develops an investment policy using the following reasoning: (i) The duration of the five-year zero coupon bonds is 5. (ii) The duration of the preferred stock is 13.5. (iii) The duration of the obligation to the customer is 10. (iv) Taking the weighted average of the durations, the amount invested in five-year zero coupon bonds is chosen to be 13.5 - 10 * (85,000) = $35,000 13.5 - 5 while the amount invested in preferred stock is chosen to be 10 - 5 13.5 5 * (85,000) $50,000 Verify that this investment strategy is optimal under immunization theory, assuming the customer leaves the funds on deposit for the full ten-year period
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