need 1 pages double spaced discusion on the question below

Business Finance

mmu

Question Description

Question 1: A financial institution has the following liabilities which it is trying to immunize against a change in interest rates (all are priced to yield 8%):

  • 5-year (annual payments) 8% coupon bonds with a total par value of $38 million.
  • Three payments of $24 million, each one due at the end of the next three years.
  • 12-year (annual payments) 12% coupon bonds with a total par value of $20 million.

Available for the purpose of immunization each year are a 1-year zero coupon bond (a rolling issue, new ones each year) and consol (perpetual) bonds with a 11% coupon, both yielding 10% to maturity. Assuming that you re-balance the portfolio each year immediately after any payments are made, what is the dollar amount of each hedging instrument you will hold at t=0 and t=1 to completely neutralize the institution’s exposure to interest rate changes over the coming year?

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