Three bonds A, B, and C are traded in the markets with respe…
Three bonds A, B, and C are traded in the markets with respective prices being $98.04, $94.26 and $100.32. Bonds A and B are zero-coupon bonds with maturities 1 and 2 years, respectively. Bond C is a 3-year 5%-coupon bond with annual coupon payment paid at the end of each year (including year 3) and a face-value of $100 paid at the end of year 3. 1) Consider a new bond D which is a 3-year coupon bond with 7% coupon rate (paid annually) and a face value of $100. What is the fair value of bond D? 2) What will be the value of bond D if there is an increase of 0.1% to interest rates of all terms? 3) Suppose you owe $5,000 at the end of year 3. Concern about interest rate risk suggests that a portfolio consisting of bonds A, B, D and the obligation should be immunized. If V1, V2, and V3 are the total values of bonds purchased of types A, B, and D, respectively. What are the necessary requirements (express the requirements in terms of properly formulated equations) for setting up the immunization? (Hint: there are two equations. No need to solve them.)