Original practice · fully worked
Original variant: verify a two-zero allocation
A liability portfolio has present value 50,000, Macaulay duration 10, and convexity 120. Assets are zero-coupon bonds maturing in 6 and 18 years. What fraction of asset present value belongs in the 6-year zero to match duration, and does the resulting asset portfolio satisfy the strict Redington convexity condition?
- A
33.3%; no, convexity 84 - B
50.0%; no, convexity 108 - C
66.7%; yes, convexity 132 - D
66.7%; no, convexity 120 - E
75.0%; yes, convexity 126
Answer and calculation
Duration matching places two-thirds of present value in the 6-year zero. The asset convexity is 132, exceeding 120, so choice C is correct.
Setup
Setup
Let f be the present-value fraction in the 6-year zero; one minus f is in the 18-year zero.
6f+18(1−f)=10 Model
Model
Solve the duration equation.
f=18−618−10=32 Compute
Compute
Evaluate asset convexity using the same present-value weights.
CA=32(62)+31(182)=132 Answer
Answer
The short-zero share is 66.7% and strict convexity protection holds, choice C.
f=66.7%, CA=132>120(C)