Elliot Karlin is a? 35-year-old bank executive who has just inherited a large su

Question

Elliot Karlin is a? 35-year-old bank executive who has just inherited a large sum of money. Having spent several years in the? bank's investments? department, he's well aware of the concept of duration and decides to apply it to his bond portfolio. In? particular, Elliot intends to use $ 1 million of his inheritance to purchase 4 U.S. Treasury? bonds:
1. An 8.57 % ?, ?13-year bond? that's priced at $ 1,088.76 to yield 7.49 % .
2. A 7.813 % ?, ?15-year bond? that's priced at $ 1023.37 to yield 7.55 % .
3. A? 20-year stripped Treasury? (zero coupon)? that's priced at $ 199.28 to yield 8.23 % .
4. A? 24-year, 7.44 % bond? that's priced at $ 951.87 to yield 7.89 % .
Note that these bonds are semiannual compounding bonds.
a. Find the duration and the modified duration of each bond.
b. Find the duration of the whole bond portfolio if Elliot puts $ 250,000 into each of the 4 U.S. Treasury bonds.
c. Find the duration of the portfolio if Elliot puts $ 380,000 each into bonds 1 and 3 and $ 120,000 each into bonds 2 and 4.
d. Which portfoliolong dash b or clong dash should Elliot select if he thinks rates are about to head up and he wants to avoid as much price volatility as? possible? Explain. From which portfolio does he stand to make more in annual interest? income? Which portfolio would you? recommend, and? why?

Explanation / Answer

(a)

BOND 1

BOND 2

BOND 3

BOND 4

b)

All w=0.25

Portfolio Duration=w1D1+w2D2+w3D3+…WkDk=12.1735

c)

Similarly,

w1=w3=.38, w2=w4=0.12

Portfolio duration = 13.19

d)

To avoid volatility, long b is suggested, since its duration is less and duration is directly proportional to change in bond prices.

He stands to make more in annual interest using dash b rather than dash 3(50<59).

Portfolio b is recommended since it avoids volatility and provides higher annual interest.

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