Once upon a time, the treasurer of Mighty Corporation (MCO) decided to issue a bond (hereafter: The bond) The bond would have a 20-year life and promised that the holder of the bond would receive:

• 20 annual payments of $80,
• Along with the 20^th payment, MCO promised to return the principal of $1,000. In other words, the final payments received at maturity would be ($1000+$80) = $1080.

The insurance company wants to use The Bond as part of a portfolio designed to immunize an obligation that it foresees will come due in 15 years. (Hint: Example 11.2 in the book is very useful here).

• To create a bond portfolio with an overall duration of 15 years, the insurance company decides to buy zero coupon bonds with a maturity of 20 years (and with a YTM of 7%) to combine with The Bond . To bring the combination of The Bond plus The Zero to a combined portfolio duration of 15 years, what would be the correct mix of The Bond relative to the 20-year Zero?
  • A) percentage amount of The Bond in the portfolio
  • B) percentage amount of The Zero in the portfolio
  • C) Can you suggest a simpler investment that would give the insurance company a bond investment with a 15 year duration?