An insurance company must make payments to a customer of $10 million in 1 year (t=1) and $4 million in year 5 (t=5).

The yield curve is flat at 10%.

Parts a, b and c have been answered. Please answer parts d, e and f.

a. If it wants to fully fund and immunize its obligation to this customer with a single issue of a zero-coupon bond, what maturity bond must it purchase? Note: the answer is ONE zero-coupon bond.

Time	Cash Flow	PV @ 10%	Weight	Duration
1	$ 10,000,000.00	$9,090,909.09	0.7854	0.7854
5	$ 4,000,000.00	$2,483,685.29	0.2146	1.0729
Total		$11,574,594.38	1	1.8583
PV	$11,574,594.38
Required maturity of zero	1.8583

b. What must be the face value (i.e., the principal amount) and market value (at t=0) of that zero-coupon bond?

The zero's market value	$11,574,594.38
Face value	$13,817,413.73

C. Suppose yields next year at t=1 are 9%. What is the value of the zero that the company purchased in part (a)?

Value of the zero

12857733.14

D. Using the bond that they purchased in part (a) along with the information in part (c), how can the insurance company make the payment of $10 million at t=1? Describe any trades that they must make to generate the cash to make the payment of $10 million.

E. What is the value of the liability (after making the payment in (d)) that remains for the insurance company? Are they still close to being fully funded? Why or Why Not?

F. Given all the steps you have taken at t=1, what must the insurance company do so that they continue to be immunized. Explain.