QUESTION 10

An insurance company has claim liabilities valued at $100 million with an estimated duration of 7 years. The company currently has a $100 million bond investment portfolio with a duration of 5 years.

a. What risk does the company currently face with respect to interest rates?

b. The company would like to immunize its balance sheet from interest rate risk and is considering buying 0 coupon, 10-yr Treasury Strips. How much of its current portfolio should it sell and invest in the Treasury 0-coupons?

c. Suppose the company's financial officers strongly feel interest rates are going to increase more than anticipated by the market. Should it buy more or less Treasury 0-coupons than your answer in b? (No calculations required)