Medibank Ltd is planning to issue a guaranteed capital-gain only investment product of $100,000 per subscription unit that has a 3-year maturity and pays a single sum of guaranteed principal-cum-interests at maturity.The specified rate of return on the investment product is the prevailing market interest rate at the time of issue.

a)Design an initial immunization strategy for managing a small interest rate risk using a combination of 2- and 4-year zero-coupon bonds.Both zero-coupon bonds have anominal valueof $1000.Assume a flat yield curve for the prevailing market interest rates of all maturities. [4]

b)Immediately after the initial immunization strategy in (a) has been set up, explain what interest rate risk Medibank will face if Medibank subsequently decides to pay out interest annually rather than at maturity. [2]

c)Briefly discuss the most significant limitation of the initial immunization strategy in (a) and propose a solution with justifications. [2]