Professional Documents
Culture Documents
Immunization
Introduction
An immunized bond portfolio is
largely protected from fluctuations
in market interest rates
– Seldom possible to eliminate interest rate risk
completely
– A portfolio’s immunization can wear out,
requiring managerial action to reinstate the
portfolio
– Continually immunizing a fixed-income
portfolio can be time-consuming and technical
Bond Risks
1. Duration matching
• Bullet immunization &
• Bank immunization
2. Duration shifting
Bullet Immunization
• Seeks to ensure that a predetermined sum of money is available at
a specific time in the future regardless of interest rate movements
• Objective is to get the effects of interest rate and reinvestment rate
risk to offset
– If interest rates rise, coupon proceeds can be reinvested at a
higher rate
– If interest rates fall, proceeds can be reinvested at a lower rate
• (skip details on the example)
– Choose a bond with YTM=desired return and duration
matching the time you will need the money from the
investment
Bank Immunization
• Addresses the problem that occurs if
interest-sensitive liabilities are included
in the portfolio
– E.g., a bank’s portfolio manager is
concerned with the entire balance sheet
– A bank’s funds gap is the dollar value of its
interest rate sensitive assets (RSA) minus its
interest rate sensitive liabilities (RSL)
Bank Immunization
To immunize itself, a bank must reorganize its
balance sheet such that:
$ A DA $ L DL
where
$ A, L dollar value of interest sensitive assets or liabilities
DA, L dollar - weighted average duration of assets or liabilities
Effects of Bond Immunization
• Minimize adverse effects of Bond immunization
• Interest rate fluctuations also affect a bond's
reinvestment risk.
• Interest rate changes have opposite effects on a
bond's price and reinvestment opportunities.
• Portfolio duration= Investor’s time horizon
• Matches specified anticipated receipts to investors
liabilities
Disadvantages of BPI
• Opportunity Cost of Being Wrong
• Lower Yield
• Transaction Costs
• Immunization Is Instantaneous Only
Hedging With Interest Rate
Futures
•A financial institution can use futures
contracts to hedge interest rate risk
Pb Db (1 YTM ctd )
HR CFctd
Pf D f (1 YTM b )
Hedging With Interest Rate
Futures (cont’d)
portfoliopar value
# contracts hedgeratio
$100,000
Hedging With Interest Rate
Futures (cont’d)
Futures Hedging Example
• A bank portfolio holds $10 million face value in
government bonds with a market value of $9.7 million,
and an average YTM of 7.8%. The weighted average
duration of the portfolio is 9.0 years. The cheapest to
deliver bond has a duration of 11.14 years, a YTM of
7.1%, and a CBOT correction factor of 1.1529.
$10,000,00 0
# contracts 0.9898 98.98
$100,000