Chapter 19 - 8(this is the safety net return Determine...

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1 Chapter 4 – Portfolio Immunization and Cash Flow Matching 1. Concept of Immunization 1. Select a bond with an effective duration equal to the duration of the liability 2. Set the PV of the bond equal to the PV of the liability 2. Adjustments to the immunized portfolio 1. Durations drift with interest rates 2. Time passes 3. Bond characteristics that must be considered while immunizing are: 1. Credit rating 2. Embedded options 3. Liquidity 4. Contingent Immunization and its application 1. Calculate cushion spread 2. Required terminal value 3. Dollar safety margin 5. You have decided to pursue a contingent immunization strategy over a 3-year time horizon. You just purchased at par $20million worth of 9%, semiannual coupon, 15-year bonds. The current rate of return for immunized strategies is 9%, and you are willing to accept a return of
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Unformatted text preview: 8% (this is the safety net return). Determine cushion spread, terminal value and whether active management is still viable if rates rise to 12%. (100bps, $25.3M, $567k, -$1.97M) 6. Cash Flow Matching 1. Select a bond with a maturity date equal to that of the last liability 2. Buy enough in par value of this bond such that its principal and final coupon fully fund the last liability 3. Work backwards and choose bonds to match liability cash flows 7. The importance of selecting a discount rate to compute PV of liabilities 8. End of chapter question: 12 (page 125 & 126) 9. Homework problems:...
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