- Does cash flow matching strategy has immunization (reinvestment) risk? Schweser practice exam vol. 2 Q19.6 says it does not, while Schweser Note Bk 3 page 150 says “reinvestment risk is inherent in CF matching.” 2. if a clients wants to hold stocks regardless of the value of her portfolio, I interpret it as her risk tolerance is constant regardless of wealth. But schweser answer key says the client has risk tolerance that varies proportionally with her wealth. Can anyone explain? This is Q16.5 of the same exam. Thanks.
on first question, i think full cash flow matching has no reinvestment risk. on the second question, i found that whole risk aversion and rebalancing very confusing. so can’t really help… independent of studying curriculum, i think i’d call that constant aversion too.
I would think too that cash flow matching has no reinvestment risk. unless you use the hibrid method ( don’t recall the method now) with cash flow matching for the bgn of the period. for the second one- two methods - buy and hold and the convex/insurance strategy have such a structure that the risk tolerance increases/decreases with the wealth. only for constant mix you can say that the individual has constant risk tolerance independent of wealth level because of rebalancing
just to add. in your case - hold stock no matter how big the portfolio is you can eliminate the convex strategy, because if it falls under the minimum accepted stocks will have a 0 weighting.
A simpler way to look at the second point is If you buy and hold, when market goes up and your portfolio goes up your equity % of portfolio goes up too. This means you have risk tolerance correlate with wealth.
florinpop Wrote: ------------------------------------------------------- > I would think too that cash flow matching has no > reinvestment risk. unless you use the hibrid > method ( don’t recall the method now) with cash > flow matching for the bgn of the period. Would you please explain why cash flow matching has no reinvestment risk? Schweser Book 3 page 150 says “Cash flow matching depends upon all the cash flows of the portfolio, so expectations regarding short term reinvestment rates are critical”.
- As west said, it has reinvestment risk if its not perfectly matched, but for full cash flow matching I too believe theres no reinvestment risk. I also got that question wrong, believe its one of those schweser questions. 2. serf_dude’s explanation gives the answer.
gauravku Wrote: ------------------------------------------------------- > 1. As west said, it has reinvestment risk if its > not perfectly matched, but for full cash flow > matching I too believe theres no reinvestment > risk. I also got that question wrong, believe its > one of those schweser questions. > 2. serf_dude’s explanation gives the answer. I would agree that if the CF can exactly match the liability stream, then no reinvestment risk. However, according to Schweser Note: since it is extremely unlikely that CFs can match liability streams, reinvestment risk is inherent in cash flow matching strategy, and thus short term rates are critical. Now the question is do we assume it is a full cash flow matching strategy? Q19.6 didn’t say it’s a full cash flow matching strategy.
florinpop Wrote: ------------------------------------------------------- > just to add. in your case - hold stock no matter > how big the portfolio is you can eliminate the > convex strategy, because if it falls under the > minimum accepted stocks will have a 0 weighting. Yes, I immediately cross out CPPI. But my question is if the client wants to hold stocks regardless of the value of her portfolio, why you interpret the client has risk tolerance that varies proportionally with her wealth? I interpret as constant risk tolerance regardless of wealth. This is the key point to get the right answer.