liability-mimicking portfolio understand, totally, please, those

Carson

EOC Volume 2 Page 464 #2 and #3.

I totally don't understand what the hell those are.

An explanation from A-to-Z please.....



thx.

skycfa

The components of a pension fund's liabilities can be categorized as inflation-adjusted or not inflation adjusted.

Real return bonds will best mimic the components of the liability that are inflation-adjusted.

Nominal bonds are best used to mimic the components of the liability that are not inflation adjusted.

It should explain which components are inflation-adjusted and not inflation-adjusted in the text...

Zestt

I guess it is terminology.
nominal has inflation built in, real is no inflation.

r nominal = r real + inflation.

Or (1+r nominal) = (1 + r real) * (1 + inflation)

CP

ll11

Nominal bonds are not adjusted for inflation. Real bonds are adjusted to provide a given real return as inflation changes. Question 2 explains that real bonds are inflation-indexed.

Can't tell if this conflicts with your explanation, CP.

Jin: For question 2, the case explains that current retiree benefits will continue have the COLA feature.

infinitybenzo

But why is the payment to retirees sensitive to CPI? Isn't the payment supposed to be fixed?

alaaq80 Wrote:
-------------------------------------------------------
> Hi , in #2, bonds that are sensitive to CPI are
> mimicked by real growth bond (unexpected
> inflation) as well as future pmts.
> in #3, bonds and future pmts not sensitive to CPI
> or equity are considered as future payments to be
> mimicked by nominal bonds. Note the similarities
> between those liabilities and nominal bonds as
> both are considering expected inflation only.