Suppose you are a pension fund manager and you have a three year obligation of $120 million. You would like to dedicate the amount of money needed for that today and hope you can make rate of return of 6% on it.
A.) Assuming you can find a three year zero with 6% rate of return, how muich money do you need to dedicate today in order to have $120 million in three years?
B.) Now assume you can't find a three year zero with 6% YTM, but you do find the following bonds with 6% YTM:
A five year, 8% semi-annual bond
A four year, 9% semi-annual bond
A one year zero bond
They are all fairly priced. What bonds are the best ones to choose for a dedicated, immunized portfolio?
C.) Calcuate the dollar amounts you need to put in each bond and the number of bond of each you need to buy. (Note: This part is the "meat" of the whole exercise where you need to do most of the calcuations.)