27UIUC%20FIN%20300%20Duration%20Matching%20Immunization%20Example%201-3%20FA09

27UIUC%20FIN%20300%20Duration%20Matching%20Immunization%20Example%201-3%20FA09

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UNIVERSITY OF ILLINOIS College of Business - Department of Finance - Finance 300 (Financial Markets) Professor James Jackson Duration Matching & Immunization 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 $500,000.00 $471,297.95 0.54517 Market Rate (YTM %) 4 $500,000.00 $444,243.52 1.02775 6.00% 6 $500,000.00 $418,742.13 1.45313 Risk Free Rate % 8 $500,000.00 $394,704.62 1.82629 3.00% (∑ PVCF $) = $1,728,988.22 ∑/2 = Duration (Years) 2.4262 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.
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