Duration Matching Immunization practice problem

Duration Matching Immunization practice problem -...

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UNIVERSITY OF ILLINOIS College of Business - Department of Finance Finance 300 (Financial Markets) Example Question #1 Question: You are asked to set up a trust that has a liability schedule of cash outflows of $500,000 per year for four years. The two bond issues available to meet the cash out flow payments are quoted with the coupon rate, duration, and price information in the table below. How do you immunize the portfolio? Answer: Follow the eight immunization steps. 1. Calculate the duration of the liabilities. Liability (Time Periods) Cash Flow (CF$) PV (C$) Duration (D i ) 2 Market Rate (YTM %) 4 6.00% 6 Risk Free Rate % 8 3.00% (∑ PVCF $) = ∑/2 = Duration (Years) Bond #1 Coupon Rate Bond #1 Duration Bond #1 Price Bond #2 Coupon Rate Bond #2 Duration Bond #2 Price 4.00% 2.00 $975.00 7.00% 6.00 $1,125.50 2. Calculate the weights of the available fixed income assets based on their respective durations. Solve for the portfolio weights for each asset: W4 + W7 = 1.00 2.00 * W4 + 6.00 * W7 = 2.4262 W4 + W7 = 1.00 2.0 * W4 + 6.00 * W7 = 2.4262 3. Calculate the required number of each bond to be purchased in the portfolio.
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This note was uploaded on 08/30/2009 for the course FIN 300 taught by Professor Jackson during the Spring '07 term at University of Illinois at Urbana–Champaign.

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Duration Matching Immunization practice problem -...

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