An insurance firm needs to make a payment of $10000 in 3 years, the market interest rate to discount this obligation is 1%. The insurance firm funds this obligation with a 4-year zero-coupon bond and a 2-year coupon bond with a coupon rate of 10% (The coupon payments are made annually). Both bonds have a face value of $1000 and a yield of 1%. What is the price of the 2-year coupon bond? What is the duration of the 2-year coupon bond? What is the portfolio weight on the 2-year coupon bond to immunize the insurance firm’s obligation?
Debenture Valuation
A debenture is a private and long-term debt instrument issued by financial, non-financial institutions, governments, or corporations. A debenture is classified as a type of bond, where the instrument carries a fixed rate of interest, commonly known as the ‘coupon rate.’ Debentures are documented in an indenture, clearly specifying the type of debenture, the rate and method of interest computation, and maturity date.
Note Valuation
It is the process to determine the value or worth of an asset, liability, debt of the company. It can be determined by many processes or techniques. Many factors can impact the valuation of an asset, liability, or the company, like:
- An insurance firm needs to make a payment of $10000 in 3 years, the market interest rate to discount this obligation is 1%. The insurance firm funds this obligation with a 4-year zero-coupon bond and a 2-year coupon bond with a coupon rate of 10% (The coupon payments are made annually). Both bonds have a face value of $1000 and a yield of 1%.
- What is the price of the 2-year coupon bond?
- What is the duration of the 2-year coupon bond?
- What is the portfolio weight on the 2-year coupon bond to immunize the insurance firm’s obligation?
- How much money should the firm invest in the 2-year coupon bond?
Assume one year has passed, the firm needs to rebalance its portfolio to make sure its obligation is still immunized. Assume the market interest rate and the yields do not change.
- What is the duration of the 2-year coupon bond?
- What is the portfolio weight on the 2-year coupon bond to immunize the insurance firm’s obligation?
- How much money should the firm invest in the 2-year coupon bond?
Step by step
Solved in 5 steps with 2 images
