The following portfolio will be used:

Long $40 million of invested in 2-year coupon bond paying 9% annually

Short $30 million of a 1-year zero coupon bond.

Q7. You are standing on February 15,1994 (yield curve at 5% flat)

(a) What is the total value of the portfolio? Find out the number of each bond in the portfolio (all the bonds have face value of $100).

(b) Compute the dollar duration of the portfolio.

Q8. You are worried about interest rate volatility. You decide to hedge your portfolio with a 10-year zero coupon bond (face value $100).

(a) How much should you go short/long on this bond in order to make it immune to interest rate changes? Find out both the total dollar amount and the number of such bond.

(b) What is the total value of the portfolio now?

Q9. Assume that it is now August 13, 1994 and that the yield curve has changed accordingly (7% flat).

(a) What is the value of the unhedged portfolio now? (b) What is the value of the hedged portfolio?

(c) Is the value the same? Did the immunization strategy work?

Q10. Instead of assuming that the change took place 6 months later, assume that the change in the yield curve occurred an instant after February 15,1994.

(a) What is the value of the unhedged portfolio?

(b) What is the value of the hedged portfolio? Did the immunization strategy work?

Q11. Now use the February 15,1994 yield curve to price the stream of cash flows on August 13, 1994. (a) What is the value of the unhedged portfolio?

(b) What is the value of the hedged portfolio?