solution

1. The portfolio manager of a pension fund has been assigned a new account; the account is scheduled to pay out $2.5 million/year. Since the company’s business can be viewed as indefinite, these payments will be made in perpetuity.

Generally, the PM has used zero coupon bonds to immunize the risk associated with obligations of this kind. She is thinking about the 9 year and the 17 year maturity buckets for the zero coupon bonds. Current market rates are 6.95%.

1. What is the mix [% terms] of these bonds that the PM should deploy to immunize the obligation?
2. What is the market value of each of the zero coupon bonds that are deployed?