Immunizing against single liab conflict

difference, effective, liability, conflict, interest

In schweser it states that with Classical Immunization, if you match the effective duration to the liability horizon that the interest rate risk will be eliminated. (price/reinvestment) (pg. 21 book 3)

However,

Shortly after that, it states that if CFA asks a question similar to.."as long as the portfolio manager matches the duration and convexity of the portfolio to the liability, whether he uses a barbell or bullet strategy makes no difference"... That we should disagree with this and explain that barbell will have more reinvestment risk than a bullet. (pg. 37 book 3)

I understand the dispersion around the liability date concept, however, I don't understand why this should be disagreed with given the prior statement from Classical Immunication.

Any feedback?

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NakedPuts2011

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发表于 2011-7-11 19:57 | 只看该作者

The first statement applies to immunizing a single liability. In your 2nd paragraph, they may be referring to multiple liability immunization, although I'm not sure.

Using a barbell approach results in greater dispersion around the liability, creating greater immunization risk. The more clustered the hedging instruments are relative to your liability reduces immunization risk.

But in multiple liability immunization, the range of your assets have to be wider than your liabilities, so this may be where the barbell approach comes into play.

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Windjammer

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发表于 2011-7-11 19:57 | 只看该作者

Classical immunization assumes that you are immunizing against a single liability, and the yield curve makes a one-time parallel shift. This is an overly simplistic assumption since most liabilities aren't going to be bullet payments. Once you start to incorporate more realistic assumptions (i.e., multiple liabilities, non-parallel shifts, etc.), things get more complicated and you have to start thinking more about price risk and reinvestment risk.

A barbell strategy is going to have more interim coupon payments before your liability becomes due, thus you'll need to reinvest those coupons, meaning you have higher reinvestment risk.

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