Immunization Risk Question free, liability, regarding, matching, multiple

zbird2134

Schwser VOL II Exam3 Q19.6
As an alternative to multiple liability immunization, the Cicatrix pension fund could employ a cash flow matching strategy. A cash flow matching strategy would be free from immunization risk and typically would require less capital to fund the pension liabilities.
Are the comments correct regarding immunization riska nd capital requirements for a cash flow matching strategy? Please explain

franzino

^ I was looking over CFAI stuff and Cash Flow matching is more expensive.
Not sure but may be because it uses a more conservative rate of return assumption? Anyone with insights on that?

ishfaque

I read the same thing as Gmofden. confused

maxmeomeo

I agree with Leo_land on the reinvestment risk. ( But the schwser answer says otherwise. The answer says BOTH arguments are CORRECT)
On the capital requirement side, shouldn’t both immunization and cash flow strategies require the same amount of capital=pv(liability). Although cash flow needs better time match, whereas immunization only requires the average amount of capital to be equal, not the distribution patter? Why one is higher in term of capital requirement?

YouCanDoIt

The comment regarding immunization risk is correct. By cash flow matching, you effectively use zero coupon bonds to match the cash flow liabilities, and therefore removing all the reinvestment risk.
The comment about less capital to fund the cash flow matching is not correct. This is because you will have to purchase a zero coupon bond for exactly the amount and date of the cash flow liability, this can be expensive because you have to buy from a limited pool of bonds regardless of liquidity..