Question

a life insurance company expects to pay the beneficiary of a policy $3,000,000 in 15 years from today. suppose the manager of the insurance company wants to immunize her firm against interest rate risk and has two assets available as investments. the assets' information is below: bond time-to-maturity coupon rate yield price duration bond a 20 years 10% 6% $1,458.80 11.03 years bond b 30 years 4% 6% $724.70 15.80 years how many of bond a should the insurance company purchase to immunize against interest rate risk? group of answer choices 694 bonds 345 bonds 714 bonds 144 bonds 290 bonds

Answer 1

To immunize against interest rate risk, the insurance company should invest in bond A and purchase 694 bonds.

Step-by-step explanation:

To immunize against interest rate risk, the insurance company should invest in bond A.

This is because the duration of bond A is closer to the time horizon of the liability (15 years) compared to bond B.

Duration measures the sensitivity of the bond's price to changes in interest rates, and a lower duration indicates lower interest rate risk. Bond A has a duration of 11.03 years, while bond B has a duration of 15.80 years.

In order to immunize, the insurance company should match the duration of the assets with the time horizon of the liability. Therefore, the insurance company should purchase 694 bonds of bond A to immunize against interest rate risk.