URGENT!! You are managing a fund with obligations to make payments of $1.3 million, $2.3 million, and $1.3 million at the end of each of the next three years, respectively. The annual interest rate is 12%. You wish to immunize your position by investing in one-year zero-coupon bonds and perpetuities. How much you should allocate to the one-year zero-coupon bonds and perpetuities to fund your plan?
Present Value of obligations =
=
= 3,919,574.53
Duration of Payments =
= 7603749.09 / 3,919,574.53
= 1.94 years _ _ _ (A)
let the weight in ZCB be x, weight in perpetuity will be 1-x
Duration of Zero coupon Bond 1
Duration of perpetuity = 1.12 / 0/12 = 9.33333333333
Equating Equation A with WEighted duration of ZCB and Perpetuity
1.94 = Duration of ZCB * Weight of ZCB + Duration of perpetuity * Weight of perpetuity
1.94 = 1 * x + 9.33333333333 * (1-x)
1.94 = 1 * x + 9.33333333333 - 9.33333333333 * x
1.94 = 9.33333333333 - 8.33333333333 * x
x = (9.33333333333 - 1.94) / 8.33333333333
x = 0.8871 OR 88.72%
Weight of ZCB = 88.71%
Weight of Perpetuity = 100% - 88.71%
= 11.28%
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