Contingent Immunization

[Bronson Charley]

Hi
Can someone advise what happens to the dollar safety margin when rates fall? Please include how is the margin calculated
Thanks

 

[S2000magician]

It depends on the duration of the liabilities versus the duration of the assets.
If the assets have a higher duration than the liabilities, the safety margin (PV(assets) − PV(liabilities)) will increase when interest rates fall. If the assets have a lower duration than the liabilities, the safety margin will decrease when interest rates fall.

 

[arigolden]

S2000magician wrote:
It depends on the duration of the liabilities versus the duration of the assets.
If the assets have a higher duration than the liabilities, the safety margin (PV(assets) − PV(liabilities)) will increase when interest rates fall. If the assets have a lower duration than the liabilities, the safety margin will decrease when interest rates fall.

S2000magician, can I extend your explanation above by saying that the reason the safety margin falls when DurationAssets < DurationLiabilities is because when interest rates fall, the PV of that Liability becomes even higher which means the liability is becoming larger?

 

[sfad]

If duration of assets < duration of liablities, when interest rates fall, the asset gains value (due to lower NPV) but the liabilities gain even more value (due to lower NPV). So overall value decreases.