Immunization (Cushion spreads and such) number, returns, manager, problems, couple

pimpineasy

I know there has been a lot of talk on this on the boards, but just wanted a quick answer here:

For each problem when they talk about "the manager has an acceptable return of 5%". Where does this number play in any of the calculations at all? I have done a couple of problems and never once had to use there acceptable returns.....

Lemme know and thx in advance!

mp3bu

That would be the value that is used to find the terminal value of the liability of the portfolio.

i.e. 100MM to invest now for 3 years. 100(1.025)^6 would give the terminal value. Then obviously that value discounted by the current immunization rate.



Edited 1 time(s). Last edit at Tuesday, May 31, 2011 at 12:02PM by Paraguay.

cityboy

Oh ok.

So hypothetically:


100M for 5 years at a acceptable rate of 5% (semiannual) = 128M terminal value

Immunization rate = 6% (semiannual) = 128 / (1.03)^10 = 95.24M

Currently own a bond at 100M, 10 year semi annual, with 6% coupon. = 100M (since immunization rate = coupon it is trading at par)

If rates increased by 2% to 8% immediately

Current PV Bond:

n = 20
IR = 4%
PMT = 3M
FV = 100M
PV = calculated = -86409673.66

Revised Immunization trigger point (whats the name of this number again?)

128M / (1.04)^10 = 86.47M


Since 86.40 < 86.47 , immunization is triggered


Anything wrong here?

ohai

No, it always seems like rates have to move a lot for immunization to be triggered.

liangfeng

Okay but the math and the logic is correct? Like if the rates moved up by 7% then odds are I would have to use immunization.

IAmNeil

Yeah everything is correct. I just am always shocked when doing the math how much rates need to move.