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Duration &acirc;€“ Insurance Co

# Duration &acirc;€“ Insurance Co - Duration...

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Duration – Insurance Co. Example 1 We’ll use insurance companies to illustrate interest rate risk. Policy calls for the payment of a lump sum at the policyholder’s retirement. The value of the account must be sufficient the make the payment. Suppose it is 2010; the payment of \$1,469 is due in five years in 2015. To immunize the firm from interest rate risk, FI

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2 What options are there? Buy a 5-year Maturity (Zero) Bond Buy a 5-year Duration Coupon Bond Duration – Insurance Co. Example
3 Option 1 - Buy a 5-year Maturity (Zero) Bond Remember that a discount bond pays no interest. The firm could buy a 5-year bond, as follows: \$1,000 / (1 + .08)5 = \$680.58 Since they will need \$1,469 (not \$1,000), they will need to buy 1.469 bonds (for each \$1,000 in coverage). Duration – Insurance Co. Example

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4 Option 2 - Buy a 5- year Duration Coupon Bond The bond we looked at earlier has a duration of 4.993 years, or about 5-years.
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Duration &acirc;€“ Insurance Co - Duration...

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