Question
Hands Insurance Company issued a $90 million, 1-year, zero-coupon note at 8 percent add-on annual interest (paying one coupon at the end of the year).
Hands Insurance Company issued a $90 million, 1-year, zero-coupon note at 8 percent add-on annual interest (paying one coupon at the end of the year). The proceeds were used to fund a $100 million, 2-year commercial loan at 10 percent annual interest. Immediately after these transactions were simultaneously closed, all market interest rates increased 2 percent .
a. What is the true market value of the loan investment and the liability after the change in interest rates?
b. What impact did these changes in market value have on the market value of the equity?
c. What was the duration of the loan investment and the liability at the time of issuance?
d. Use these duration values to calculate the expected change in the value of the loan and the liability for the predicted increase of 2 percent in interest rates.
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