Immunization

[der Pate]

What i do not get is the difference between single liability immunization and multiple liability immunization. With Multiple, it says the distribution of durations should exceed the distributiion of the liabilities, in order to have enough cash on hand for the outflows. That sounds intuitive. With single liabilities however, maturities should be concentrated around the horizon date (Bullet strategy e.g. one year before and one year afterwards). If i have a portfolio with a bond maturity after the liability, i will not have enough cash on hand, right? or is it assumed the bond will be sold?

 

[S666]

It’s assumed the bond will be sold - and any adverse price risk you have suffered on the longer term bond through rising interest rates at the time of sale, will be offset by the positive reinvestment risk effect seen on the shorter term bond.

 

[MrSmart]

S666 wrote:
It’s assumed the bond will be sold - and any adverse price risk you have suffered on the longer term bond through rising interest rates at the time of sale, will be offset by the positive reinvestment risk effect seen on the shorter term bond.

That’s not completely true. And you would probably be better off borrowing than selling.

 

[S666]

MrSmart wrote:

S666 wrote:
It’s assumed the bond will be sold - and any adverse price risk you have suffered on the longer term bond through rising interest rates at the time of sale, will be offset by the positive reinvestment risk effect seen on the shorter term bond.

That’s not completely true. And you would probably be better off borrowing than selling.

Eeugh fine the bond will be sold/monetised/borrowed against….for all intents and purposes, same difference.

 

[MrSmart]

If the yield curve is upward sloping, and let’s say you bought the bond at 8% YTM (assume zero), with one year left to maturity.
Would you rather sell the bond, or borrow at 3-5%?
I could see this as a question on the exam, there’s a difference.

 

[S666]

If the prevailing rates available at the time are 3-5% then you’re not going to earn 8% on your zero, even if when you bought it you were getting an 8% YTM…it would be discounted for that final year at the prevailing 1 year rate.

 

[onlysimon]

the fact the text makes such a big play of having a dispersion of maturities means it’s ripe for testing. i’d say an OTC swap is probably what you get left with.

 

[MrSmart]

S666 wrote:
If the prevailing rates available at the time are 3-5% then you’re not going to earn 8% on your zero, even if when you bought it you were getting an 8% YTM…it would be discounted for that final year at the prevailing 1 year rate.

Oh, right.

 

[olivia_x]

der Pate wrote:
What i do not get is the difference between single liability immunization and multiple liability immunization. With Multiple, it says the distribution of durations should exceed the distributiion of the liabilities, in order to have enough cash on hand for the outflows. That sounds intuitive. With single liabilities however, maturities should be concentrated around the horizon date (Bullet strategy e.g. one year before and one year afterwards). If i have a portfolio with a bond maturity after the liability, i will not have enough cash on hand, right? or is it assumed the bond will be sold?

I agree with the last parts highlighted - assume liabiity payments due in 10 years, but the two bond portfolios are due in year 6 and 14. After the first oen due you would worry about reinvestment risk for the remaining 4 years especially if the interest rate starts to go down; and on year 10 you would worry about the other bond maturing 4 years later. If the current interest rate is higher then you would have to sell the second bond at current unfavorable interest rate with a unfavorable price, which might or might not be able to cover the remaining liability payments.

 

[onlysimon]

correct answer - 2points.!

 

[S666]

MrSmart wrote:

S666 wrote:
If the prevailing rates available at the time are 3-5% then you’re not going to earn 8% on your zero, even if when you bought it you were getting an 8% YTM…it would be discounted for that final year at the prevailing 1 year rate.

Yes? No? Not sure what the smiley face represents…
Oh, right.

 

[MrSmart]

S666 wrote:
Yes? No? Not sure what the smiley face represents…

You’re right, I’m wrong.
If you could borrow at the same spread(s) as the bond in question, then their YTM at that point would make no difference. It’s PV would be priced at the 1-year spot rate, simillar to borrowing for that period.