Question

You will be paying $10,300 a year in tuition expenses at the end of the next two years. Bonds currently yield 8%.

a. What is the present value and duration of your obligation?

b. What is the duration of a zero-coupon bond that would immunize your obligation and its future redemption value?
You buy a zero-coupon bond with value and duration equal to your obligation.
c-1. Now suppose that rates immediately increase to 9%. What happens to your net position, that is, to the difference between the value of the bond and that of your tuition obligation?

c-2. What if rates fall to 7%?

Answer 1

Present value of obligation is: 10,300(Cumulative PVF at 8% for two years)=10,300*1.783=$18,367.63

Duration of obligation is 1.4808 years.

The duration of a zero-coupon bond is 1.4808 years would immunize the obligation. $18,367.63(1.08)1.4808=$20,584.82.

If interest obligation increases to 9%, the value of the bond would be $18,118.65 and it changed by $0.19, the same is for if it falls to seven percent.

Hope this helps, now you know the answer and how to do it. HAVE A BLESSED AND WONDERFUL DAY! As well as a great rest of Black History Month! :-)

- Cutiepatutie ☺❀❤