bond immunization portfolios

There is a section of the Kaplan materials in LOS 23c (reading 23 lia-driven & index based strategies) and one problem says a company wants to retire some of its debt early. They walk through first the possibility of a tender offer but this option isn’t viable because the price would be too high. Then they introduce the idea of setting up a portfolio of gov bonds which would create a cash-flow matching portfolio, which could be removed from the company’s balance sheet. But they also tell you this option is ‘too costly’ as well. So the solution is to use a duration-matching portfolio instead, with corporate bonds.

I think I’m missing the reason a duration-matching portfolio is the solution here, why its less costly to set up, etc. What are a few examples of what situation would best call for a dur-matching vs a CF-matching portfolio to address your liabilities? Maybe I just did a poor job of reading but I didn’t think the LOS was very clear on these questions…


Generally govt. bonds are rated higher than corporate bonds and have lower yields, so cash flow matching with govt. bonds you need to shell out more money. Duration matching with corporate bonds or even with derivatives can be potentially less costly.

Duration matching is done on longer term liabs. You’ll buy bonds in a way by whih your longer term liabs are met.

Cash flow matching is done to meet current/short term liabs and accordingly those kind of bonds would be chosen.


This is not exactly correct.

Mixing cash flow and duration matching strategies is known as “horizon matching” (a hybrid approach). It doesn’t imply that CF is only for short term and duration only for long term liabilities.

Agreed but he’s considering them both in isolation. He’s not combining them.