Bond immunisation

[patso]

Which one is a factor not considered when implementing a bond immunization strategy:
A. The credit quality of the issue;
B. Whether the issue contains an embedded option;
C. How liquid the issue is.
D. Coupon rate of the bonds
The answer is D. I thought one of immunisation objectives is to ensure you meet the lialitilies by matching the investment. Hence one would consider the coupon rate of the bond investments to check if the cashflows would match the liabilities.?

 

[Galli]

You don’t necessarily have to have a coupon “rate” that matches, just the cash flow from the coupon that matches.
You could have a zero-coupon bond immunize your bond as long as the cashflows are aligned.

 

[Unemployed]

Furthermore, with the classic bond immunization strategy, all you need is to match duration, not even matching cash flows .

 

[Galli]

Unemployed wrote:
Furthermore, with the classic bond immunization strategy, all you need is to match duration, not even matching cash flows .

yep you’re right. I keep confusing ALM with bond immuzations!

 

[cpk123]

question however is what duration are you matching? Effective / Modified / McAulay?
Effective duration = price change of bond for 1% change in rate. I do not think this is what is being matched.
Modified - same as above - but for bonds with embedded options - again I do not think this is what is being matched.
If now - as per the above - Mcaulay Duration is being matched - the cash flows * the period is the measure - and hence it must be both cash flow matched and the effective duration matched - otherwise your immunization will fall short. I think in the later half of the chapter - they do talk about this.
S2000Magician - please correct if I am misstating something in the above.

 

[S2000magician]

This is an area where CFA Institute is especially sloppy.
For liabilities, they calculate the duration as the time until the liability is due. This is Macaulay duration.
For the assets, they tell you to choose bonds whose duration (modified or effective duration, as you wouldn’t want to use bonds with embedded options, so these will be the same) matches the duration of the liabilities. So you’re matching the modified duration of assets to the Macaulay duration of liabilities.
Sloppy.
Properly, you should calculate the modified duration of the liabilities (= Macaulay duration / (1 + YTM/2)) and match the modified duration of the assets to the modified duration of the liabilities.
It’s a subtlety that the curriculum misses.