Cash flow matching vs Multiple liability immunization

Please assist, I don’t get the CFAI books anymore. Question 13 of reading 28. The answers indicate that Cash flow matching has generally less risk than multiple liability immunization. When I read the text on page 44, first paragraph of 4.2.1. I understand that minimum immunization risk approach is better than cash flow matching. Where do I go wrong? Thanks for your help!

cash flow matching is “set it and forget it” immunization you must monitor and rebalance constantly, making it more risky

cash flow matching might have less risk “once set up”, but that shouldn’t be the only consideration. Needs to be costs effective as well. haven’t read the text though.

Cash flow matching has less reinvestment risk

Text info… CFAI Text (pg 44-45): “…a minimum immunization risk approach should be as good as cash flow matching and likely will be better, because an immunization strategy would require less money to fund liabilities” Two reasons given: CF matching requires conservative return assumption for ST cash, second, funds from cash flow matched must be available when each liability due. “Most cases cash flow matching will be technically inferior to immunization” Yet in the answers: Cash flow matching has less risk of not satisfying future liabilities, multiple liability costs less. I understand how multi costs less, but why is CF matching less risky? Its never explicity said in the text from what I can see. Any help?

muffin09 Wrote: ------------------------------------------------------- > Text info… > > CFAI Text (pg 44-45): “…a minimum immunization > risk approach should be as good as cash flow > matching and likely will be better, because an > immunization strategy would require less money to > fund liabilities” Two reasons given: CF matching > requires conservative return assumption for ST > cash, second, funds from cash flow matched must be > available when each liability due. > > “Most cases cash flow matching will be technically > inferior to immunization” > > Yet in the answers: Cash flow matching has less > risk of not satisfying future liabilities, > multiple liability costs less. > > I understand how multi costs less, but why is CF > matching less risky? Its never explicity said in > the text from what I can see. > > Any help? Assuming no credit events, you’re structuring your assets in order to fully fund liabilities at the horizon date, regardless of how the yield curve shifts/twists. If I needed $105,000 to pay a liabilities a year from now and currently had $100,000 in cash, assuming a 5% 1 year risk free rate, I could just invest in a 1 year T-bill at 5% and ensure I have enough to meet my liability. Interest rates could go up 10% over that year, but it doesn’t matter since I have enough to fund my liability. With immunization, you have to make adjustments because duration changes with the passage of time.

muffin09 Wrote: ------------------------------------------------------- > Text info… > > CFAI Text (pg 44-45): “…a minimum immunization > risk approach should be as good as cash flow > matching and likely will be better, because an > immunization strategy would require less money to > fund liabilities” Two reasons given: CF matching > requires conservative return assumption for ST > cash, second, funds from cash flow matched must be > available when each liability due. > > “Most cases cash flow matching will be technically > inferior to immunization” > > Yet in the answers: Cash flow matching has less > risk of not satisfying future liabilities, > multiple liability costs less. > > I understand how multi costs less, but why is CF > matching less risky? Its never explicity said in > the text from what I can see. > > Any help? Thanks for this. It’s this sentence that creates the confusion: “Most cases cash flow matching will be technically inferior to immunization”.

Unless you know with absolute certainty the exact dates of cash flow liability requirement , it would be hard to match the asset-liability flows to leave nothing on the table at all times. With the focus on keeping the cash available when it is going to be required to meet the spnding requirement, it would be almost impossible to plan ahead for the longer term flows. Hence it would be technically inferior to immuniztion . Keeping cash on hand would lower the net rate of return and lower the duration unnecessarily. Combo or horizon matching attempts to match cash flow only in the near term when flows are known more precisely , and immunization for longer terms , when the exact opposite it true

janakisri Wrote: ------------------------------------------------------- > Unless you know with absolute certainty the exact > dates of cash flow liability requirement , it > would be hard to match the asset-liability flows > to leave nothing on the table at all times. > > With the focus on keeping the cash available when > it is going to be required to meet the spnding > requirement, it would be almost impossible to plan > ahead for the longer term flows. Hence it would be > technically inferior to immuniztion . Keeping cash > on hand would lower the net rate of return and > lower the duration unnecessarily. > > Combo or horizon matching attempts to match cash > flow only in the near term when flows are known > more precisely , and immunization for longer terms > , when the exact opposite it true Plausible story, now I understand. Thanks janakisri! I love this forum :slight_smile:

is cash flow matching inferior only to multiple liab immunization or to both multiple and classic immunization?? the text doesnt state this clearly, but it is my understanding that for a single future cash flow goal, cash flow matching is superior over classic immunization, but when you have multiple future cash flows, multiple liab immunization is superior.

If there is only one liability whose cash flow is 1.either periodic and known in advance or 2.only occurs at the horizon, cash flow matching would be exactly the same as immunization I think. ( I don’t make it too complicated for myself) If you have one liability only , you could model it as a bond with same characteristics as your solution, and the payoffs and risk control would match the liability perfectly ( except for credit /repayment etc ). The problem reduces to a trivial one. It is only with multiple/uncertain liabilities that we have a big issue of minimizing reinvestment risk and maintaining efficiency