Question
AIG needs to pay Bank of America a one-time payment of $8,000,000 in 6 years. As the financial manager, your job is to fund this
AIG needs to pay Bank of America a one-time payment of $8,000,000 in 6 years. As the financial manager, your job is to fund this liability and immunize the interest rate risk.
1) You choose to fund the obligation by investing in two securities: the 3-year zero-coupon bond with 8% YTM and the perpetuity with 8% yield. What is the duration of the zero-coupon bond? What is the duration of the perpetuity?
2) How much fund do you need to invest in the portfolio today based on semi-annual compounding?
3) How would you allocate your portfolio today on the two securities in 1) to immunize the interest rate risk? (i.e. match the durations of assets and liabilties)
4) What would be your assets allocation (weights) 6 months later?
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