This bank has sold a five-year guaranteed investment contract that guarantees an interest rate of 5.00% per year. I would purchase a bond with a target yield of 5.00% maturing in five years. Regardless of the direction of rates, the guaranteed value is achieved.
The defined benefit pension plan for this client has an economic surplus of zero. In order to meet the liabilities for this plan, I will construct the portfolio duration to be equal to that of the liabilities. In addition, I will have the portfolio payments be less dispersed in time than the liabilities.
Can someone explain why the above 2 statements are wrong?
2nd statement - the portfolio payments should straddle the liabilities. some less and close to the liability payoff date, others more than the liability payoffs, but still close to the liability payoff date.
This was the third choice (which was correct) and the Question was asking which was the correct strategy:
This client’s long-term medical benefits plan has known outflows over 10 years. Because perfect matching is not possible, I propose a minimum immunization risk approach, which is superior to the sophisticated linear program model used in the current cash flow matching strategy.