r Contingent Immunization • Example: Suppose you are managing a $100 million bond portfolio. Your investment horizon is 3 years, interest rates are currently 10%, and the terminal value of the portfolio in 3 years must not drop below $112 million. • If you start by following an active management strategy but experience losses, what is the trigger point at which you must switch to a passive strategy and immunize your portfolio? • Trigger Point = $1l2M/(1.l0)3 =~ 24. \$ 1"\ Interest Rate Swaps: Example • A bank holds several 30-year fixed-rate mortgages that it receives 7% on annually. • The bank has to pay current market rates (4%) to its depositors, and these rates constantly fluctuate. It's been increasing the rate that it pays on short-term deposits and is worried this trend will continue. • An insurance company is managing the risk of its investment portfolio and would like to lock in fixed payments in exchange for a floating rate payment. Interest Rate Swaps
This is the end of the preview. Sign up
access the rest of the document.
This note was uploaded on 09/07/2011 for the course FINANCE 320 taught by Professor Sapp during the Fall '10 term at Iowa State.