What is contingent immunization?

Asked By: Noel Texido | Last Updated: 28th April, 2020
Category: business and finance interest rates
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Contingent immunization is an investment approach where a fund manager switches to a defensive strategy if the portfolio return drops below a predetermined point.

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Considering this, what is duration and immunization?

Immunization, also known as multi-period immunization, is a risk-mitigation strategy that matches the duration of assets and liabilities, minimizing the impact of interest rates on net worth over time.

Additionally, what is the difference between bond immunization and cash flow matching? Immunization aims to balance the opposing effects interest rates have on price return and reinvestment return of a coupon bond. Cash flow matching relies on the availability of securities with specific principals, coupons, and maturities to work efficiently.

In this way, what is portfolio immunization?

Bond immunization is an investment strategy used to minimize the interest rate risk of bond investments by adjusting the portfolio duration to match the investor's investment time horizon. In other words, the bond is "immune" to fluctuating interest rates.

How does duration matching work?

Duration-matching is a strategy used to manage interest rate risk that involves matching the duration of the loan with the duration of the asset. Duration is the weighted-average maturity of the cash flows of the debt or asset.

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How do you match cash flow?

To implement the cash-flow matching strategy, you first need to project your future cash needs. In the example below, we need $30,000 in Year 1, $40,000 in Year 2 and $50,000 in Year 3. Next, we buy a 3-year bond (Bond A) that will return enough principal and interest to cover our expenses in Year 3.

How do you calculate duration?

The formula for the duration is a measure of a bond's sensitivity to changes in interest rate and it is calculated by dividing the sum product of discounted future cash inflow of the bond and a corresponding number of years by a sum of the discounted future cash inflow.

What is match strategy?

Matching strategy is the acquisition of investments whose payouts will coincide with an individual or firm's liabilities. Under a matching strategy, each investment is chosen based on the investor's risk profile and cash flow requirements.

How do you calculate portfolio duration?

Portfolio duration is commonly estimated as the market-value-weighted average of the yield durations of the individual bonds that compose the portfolio. The total market value of the bond portfolio is 170,000 + 850,000 + 180,000 = 1,200,000.

What is Redington immunization?

In finance, interest rate immunization, as developed by Frank Redington is a strategy that ensures that a change in interest rates will not affect the value of a portfolio. If the immunization is incomplete, these strategies are usually called hedging.

What does YTM mean?

Yield to maturity (YTM) is the total return anticipated on a bond if the bond is held until it matures. Yield to maturity is considered a long-term bond yield but is expressed as an annual rate.

What is ALM in banking?

Asset Liability Management (ALM) can be defined as a mechanism to address the risk faced by a bank due to a mismatch between assets and liabilities either due to liquidity or changes in interest rates. Liquidity is an institution's ability to meet its liabilities either by borrowing or converting assets.

What is Immunisation example?

Vaccines help protect against many diseases that used to be much more common. Examples include tetanus, diphtheria, mumps, measles, pertussis (whooping cough), meningitis, and polio. Unless a person's immune system is weakened, it is unlikely that a vaccine will give the person the infection.

What does convexity mean?

Convexity is a measure of the curvature, or the degree of the curve, in the relationship between bond prices and bond yields.

How do you manage a bond portfolio?

The four principal strategies used to manage bond portfolios are:
  1. Passive, or "buy and hold"
  2. Index matching, or "quasi-passive"
  3. Immunization, or "quasi-active"
  4. Dedicated and active.

How do assets match liabilities and duration?

Duration matching means to make the duration of assets and liabilities equal. Then, the sensitivity to interest-rate changes is: Interest rate changes makes the values of assets and liabilities change by (approximately) the same amount.

What does Modified duration mean?

Modified duration is a formula that expresses the measurable change in the value of a security in response to a change in interest rates. Modified duration follows the concept that interest rates and bond prices move in opposite directions.

How do you hedge duration of a bond portfolio?

Bond portfolio duration can be hedged by paying a fixed rate on interest rate swaps or by taking short positions in bond futures. With yield curves upward-sloping in all major currencies (see Figure 1), duration hedging pays away a higher, longer-dated yield and receives a lower, shorter-dated yield.

What is asset/liability matching?

Asset-Liability Matching is the process of investing, purchasing, selling and otherwise adjusting a company's asset holdings so that cash is available when it is needed to cover the company's liabilities. This is a prime example of the benefit of Asset-Liability Matching (ALM).

What is duration gap analysis?

The duration gap is a financial and accounting term and is typically used by banks, pension funds, or other financial institutions to measure their risk due to changes in the interest rate. The duration gap measures how well matched are the timings of cash inflows (from assets) and cash outflows (from liabilities).

What is reinvestment rate risk?

Reinvestment risk is the chance that an investor will not be able to reinvest cash flows from an investment at a rate equal to the investment's current rate of return.

What is Bond convexity and duration?

Duration and convexity are two tools used to manage the risk exposure of fixed-income investments. Duration measures the bond's sensitivity to interest rate changes. Convexity relates to the interaction between a bond's price and its yield as it experiences changes in interest rates.