Show all your work. Circle your answer choice. If you solve the problem with a financial calculator list your N, I/YR, PMT, PV, and FV inputs.

Bond 1 is a 5-year annual bond with a face value of $1,000, a coupon rate of 8%, and a yield to maturity of 7%. Bond 2 is a 20-year zero-coupon bond with a face value of $1,000 and an annually compounded yield to maturity of 4%.

1. Suppose you form a portfolio using Bond 1 and Bond 2. How many contracts of Bond 2 are necessary to hedge this portfolio from interest rate risk(immunize the portfolio)?

2. If the T-note futures price is $994, then which bond is the cheapest to deliver?