Suppose that the annual interest rate is 4%. You have a liability with a nominal value of $300, and the payment will take place in two years. Construct the duration-immunizing portfolio that trades in two pure discount bonds: a one-year pure discount bond with nominal value $100 and a three-year pure discount bond with nominal value $100.
a. How many units of each bond should the portfolio hold?
b. If the rate drops to 3.5% after one year, is the value of all your positions at that time positive or negative? How much is it exactly?
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