Q5. Gecko Life Assurance Company has received premium payments on policies that greatly exceeds the amount that it
anticipates that it will need to pay out on life insurance policies this year. It is considering investing the surplus in either 10-year bonds or 20-year bonds and is considering the following two investments:
Option 1: A 4% coupon rate bond that matures in 10 years (par value $1,000), or
Option 2: A 5% coupon rate bond that matures in 20 years (par value $1,000)
a. If the market rate of interest is 3% on 10-year bonds, what is the most that Gecko should be willing to pay for each of these bonds?
b. Gecko is worried that continued U.S. government raise the interest rate to 4% in the next few weeks. How would this affect the price of these two bonds? Which one is going to be affected more? Explain in words. Calculation is not needed.
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