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Please solve the below question step wise... Fixed income securities (21 marks) You have an obligation to pay $1,000,000 in eight years from now, and
Please solve the below question step wise...
Fixed income securities (21 marks) You have an obligation to pay $1,000,000 in eight years from now, and you would like to make an investment now that will enable you to meet this obligation. This investment will be a portfolio containing two of the following zero-coupon bonds: Bond Face Value ($) Yield to Maturity maturity (% (years) p.a.) A 1000 4% 5 B 1000 4% 10 Suppose the yield curve is flat at 4% for all maturities. Use annual compounding in this problem. (a) What is the present value of the obligation to pay $1,000,000 in eight years? (1 mark) (b) What are the prices and durations of bond A and B? (4 marks) How many of bonds A and B should you buy to fully immunise your obligation? (6 marks) (d) If yields rise by 1% for all maturities, by what percentage (approximately) will the value of your hedging portfolio (the bonds only, not the $1,000,000) obligation change? (4 marks) (e) Will your estimate in the previous question tend to over-state, under-state or perfectly estimate the percentage change in the bond prices? Explain why. (3 marks) (f) Will the bond portfolio still be a good immunizing portfolio for your obligation after 1 year? Assume the yield curve remains flat at 4%. Explain why. (3 marks) Fixed income securities (21 marks) You have an obligation to pay $1,000,000 in eight years from now, and you would like to make an investment now that will enable you to meet this obligation. This investment will be a portfolio containing two of the following zero-coupon bonds: Bond Face Value ($) Yield to Maturity maturity (% (years) p.a.) A 1000 4% 5 B 1000 4% 10 Suppose the yield curve is flat at 4% for all maturities. Use annual compounding in this problem. (a) What is the present value of the obligation to pay $1,000,000 in eight years? (1 mark) (b) What are the prices and durations of bond A and B? (4 marks) How many of bonds A and B should you buy to fully immunise your obligation? (6 marks) (d) If yields rise by 1% for all maturities, by what percentage (approximately) will the value of your hedging portfolio (the bonds only, not the $1,000,000) obligation change? (4 marks) (e) Will your estimate in the previous question tend to over-state, under-state or perfectly estimate the percentage change in the bond prices? Explain why. (3 marks) (f) Will the bond portfolio still be a good immunizing portfolio for your obligation after 1 year? Assume the yield curve remains flat at 4%. Explain whyStep by Step Solution
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