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You currently hold a 7-year fixed rate bond 5% annually. You would like to hedge against changes in the level and the slope of the yield curve and you plan to use a 1-year zero coupon bond and a 7-year zero coupon bond. Use the following table to compute the adequate positions in the hedging instruments.
Maturity β1 β2 Z(t, 1)
1.00 1.1150 -0.2540 0.9800
2.00 0.9940 -0.3010 0.9600
3.00 0.9640 -0.1470 0.9300
4.00 0.9330 0.0080 0.8900
5.00 0.9300 0.1620 0.8500
6.00 0.9260 0.3160 0.8100
7.00 0.9270 0.4230 0.7700
8.00 0.9270 0.5300 0.7300
Draw the profit diagrams at maturity for the following portfolios consisting of options. Clearly label all the important points in the diagrams.
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