Alana Insurance Sdn Bhd is obligated to pay 10 annual claims on a policy at the end of every year. The first payment is RM250,000 and each payment thereafter is to be adjusted for inflation of 2% annually (compounded).

a) If the company wishes to match their liabilities and assets using absolute matching strategy with zero coupon bond. Given below yield curve, determine the total cost to implement this strategy. [Hint: calculate set of spot rates first]

lambda t = 0.05 + 0.007t 0.0004t^2 for 0 t 10

b) Rework (a) using coupon bonds with annual coupons. Assume that the coupon bonds all have the same yield rate as the zero coupon bond above and that all sell at par.