Question
I have seen two answers for this. One is very simple and just involves dividing the $1,000 by 8% and getting $12,500. The other requires
I have seen two answers for this. One is very simple and just involves dividing the $1,000 by 8% and getting $12,500. The other requires much more math and factors in what the coupon rate of the 20 year bond should be. I dont know which direction to head in and any help would be appreciated.
Suppose that you have a liability of $1000 per year in perpetuity and the current interest rate for discounting this perpetuity is 8%. To hedge the value of this perpetuity, you decide to buy a 20-year bond (which also has a discount rate of 8%). How much of a 20-year bond do you need to buy?
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