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Unformatted text preview: dollars worth of bond X and Bond Y should you sell short to immunize your portfolio from interest rate movements? Answer: What is the MD and VEX of your portfolio? Your portfolio is worth $10 million and you have 40% invested in Bond A and 60% invested in Bond B. MD of portfolio = .4*10 + .6*20 = 16 VEX of portfolio = .4*50 + .6*60 = 56 Let Wx = percent of money to invest in Bond X and Wy = percent of money to invest in Bond Y. Find Wx and Wy such that the MD and VEX of your government portfolio is the same as the portfolio you wish to hedge. Wx*8 + Wy*18 = 16 Wx*40 + Wy*60 = 56 Solve these 2 equations and 2 unknowns for Wx = .2 Wy = .8 Thus, if you invested $10 million in the government bond portfolio with $2 million in Bond X and $8 million in Bond Y you would have a portfolio with a MD = 16 and VEX =56. To immunize your portfolio you must therefore sell short $2million worth of bond X and $8 million worth of Bond Y....
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This note was uploaded on 04/12/2008 for the course ECON 435 taught by Professor Chabot during the Winter '08 term at University of Michigan.
 Winter '08
 CHABOT

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