cash flow matching (reinvestment risk)

CFA Level III
#1

true or false? cash flow matching will still have reinvestment risk?

#2

That’s a tricky quesiton. B/c if I use Zero coupon bonds then NO, but if I use bonds with coupons and for some reason they dont exactly match up then I could have reinvestmetn risk… hmmm… I’ll still say False.

#3

man, you are top 1%, that’s exactly what i was expecting… i will write an email to CFAI re your performance on AF - you should be able to score 105% then…

#4

haha…if only it were possible. Thanks.

#5

bigwilly Wrote: ------------------------------------------------------- > That’s a tricky quesiton. B/c if I use Zero coupon > bonds then NO, but if I use bonds with coupons and > for some reason they dont exactly match up then I > could have reinvestmetn risk… > > hmmm… I’ll still say False. Yeah, I was thinking this. With coupon bonds, you can set up a cash flow match that is guaranteed to have the right cash flows at the right time, but that involves assuming a reinvestment rate of 0. Now, if you set things up like this, and some coupons come in before you actually need to spend them, you might be able to reinvest them, and you’ll get a surplus that depends on 1) how many and coupons arrive early and 2) the prevailing reinvestment rates at the time. So there will be risk in the surplus with a coupon CF match, but if they’re treasuries, you will get essentially 0 risk of not meeting your liability requirements (this assumes that you know the amount and timing of your liabilities). I don’t think they’ll really get into this though.

#6

this question is very tricky, it all depends on how you set up the optimization problem for the cash flow matching problem.

#7

If you can match perfectly yes, if not, then yes.

#8

jp, What do you mean? If you match perfectly you never have to reinvest. So where’s the risk?

#9

If you define risk as uncertainty of your return, you have reinvestment risk from reinvested coupons (if any arrive early). However, it only affects the value of your surplus. You have zero liability risk. That is, zero risk of not having funds to meet your known liabilities, because the cash flows are matched. This assuming you don’t have any bonds that default.

#10

I guessing the CFA way answer is yes

#11

bchadwick Wrote: > > I don’t think they’ll really get into this though. Dont think? In fact, if I see a question asking me to assume or infer the yield curve shape / reinvestment rates for coups off of bonds, I will take off my shorts and eat them, right in the exam room… Too much detail for them to ask…