A major requirement in managing a fixed income portfolio using a contingent immunization policy is monitoring the relationship between the current market value of the portfolio and the required value of the floor portfolio.

Assume a $400 million portfolio with a time horizon of 6 years (so payment is due at the end of year 6).

The available market rate at the initiation of the portfolio is 9%, but the client is willing to accept 8% as a floor rate to allow use of active management strategies.

The current values and current market rates at the end of year 1, 2, and 3 are as follow:

End of year Market Value ($mil) Market yield

1 $390.8 11%

2 $497.2 7%

3 $518.1 6%

Assuming semiannual compounding

a/ Calculate the required ending-wealth value for this portfolio?

b/ Calculate the value of the required floor portfolios at the end of year 1, 2, and 3.

c/ Compute the margin of error at the end of years 1, 2, and 3.

d/ Indicate the action that a portfolio manager utilizing a contingent immunization policy would take if the margin of error at the end of any year had been zero or negative.

e/ Assume that at the fourth year the manager decides to immunize. What should be the duration of the portfolio?

f/ If the manager chooses the duration calculated in e/, what will be the value of the portfolio at year 6 if there is an increase of interest rate at year 5?

Show a graph.

g/ If the manager chooses instead a portfolio with a higher duration and if there is an increase of interest rate in year 5 then will the fund have the correct amount, less money or more money than they should have?

Show a graph.