Bond A is a 4-year bond with a10%coupon rate and Bond B is a 2-year bond with a20%coupon rate. Both bonds have a face value of100, and all coupons are paid annually, starting in year 1. Consider a portfolio that consists of one unit of Bond A and one unit of Bond B. The yield curve is flat at = 5%.

a)What is the Macaulay duration of this portfolio?

b)Compute the approximate percentage change in the value of the portfolio if the interest rate increases by 200 basis points.

c)Suppose a pension fund holds this portfolio and is worried about fluctuations in its price. Explain how the fund can hedge its interest rate risk using 3-year zero-coupon bonds with a face value of100.