Chapter 7
	Bond Calculations
	Companies often buy bonds to meet a future liability or cash outlay. Such an investment is called a dedicated portfolio since the proceeds of the portfolio are dedicated to the future liability. In such a case, the portfolio is subject to reinvestment risk. Reinvestment risk occurs because the company will be reinvesting the coupon payments it receives. If the YTM on similar bonds falls, these coupon payments will be reinvested at a lower interest rate, which will result in a portfolio value that is lower than desired at maturity. Of course, if interest rates increase, the portfolio value at maturity will be higher than needed.
	Suppose Ice Cubes, Inc. has the following liability due in five years. The company is going to buy five-year bonds today to meet the future obligation. The liability and current YTM are below.
		Amount of liability:		$ 90,000,000
		Current YTM:		7.5%
		liability due in		5
	a.	At the current YTM, what is the face value of the bonds the company has to purchase today in order to meet its future obligation? Assume that the bonds in the relevant range will have the same coupon rate as the current YTM and these bonds make semiannual coupon payments.
		Value of liability today:		$ 62,690,276.91	1.44
	b.	Assume that the interest rates remain constant for the next five years. Thus, when the company reinvests the coupon payments, it will reinvest at the current YTM. What is the value of the portfolio in five years?
		28224981.76	4701770.768	2350885.384	1.480244285	0.480244285	12.00610712	0.08
	c.	Assume that immediately after the company purchases the bonds, interest rates either rise or fall by 1 percent. What is the value of the portfolio in five years under these circumstances?
		$ 62,690,276.91	90915258.67
		One way to eliminate reinvestment risk is called immunization. Rather than buying bonds with the same maturity as the liability, the company instead buys bonds with the same duration as the liability. If you think about the dedicated portfolio, if the interest rate falls, the future value of the reinvested coupon payments decreases. However, as interest rates fall, the price of the bond increases. These effects offset each other in an immunized portfolio.
		Another advantage of using duration to immunize a portfolio is that the duration of a portfolio is the weighted average of the duration of the assets in the portfolio. In other words, to find the duration of a portfolio, you take the weight of each asset multiplied by its duration and then sum the results.
		Answers to B and C in this section:
		Coupon payment
					Original YTM	YTM decrease	YTM increase
				Reinvestment YTM:	7.50%
				Coupon rate:	7.50%
		Year	Six-month period	Coupon payment	Value of reinvested coupons at Year 5 at original YTM	Value of reinvested coupons at Year 5 with YTM decrease	Value of reinvested coupons at Year 5 with YTM increase
		1	1
			2
		2	3
			4
		3	5
			6
		4	7
			8
		5	9
			10
			Future value of coupons:
			Par value received:
			Total portfolio value:
	d.	What is the duration of the liability for Ice Cubes, Inc.?