Solution says below statement is correct. But they don’t mentioned PVA vs. PVL and duration of assert vs. liability. How to know if interest rate fall, saftety margin will be higher?
“When interest rates fall, contingent immunization switches to more active management because the dollar safety margin is higher.”
If contingent immunisation is being used, then PVA > PVL. Assuming durations are equal, PVA will increase > PVL (in nominal terms, not % terms). Hence, surplus will increase.
I think because it’s an insurance company you’ll have to assume they did their job and matched the liability duration at the very least. and they’ll keep doing that as duration changes and they have at least Asset = Liability.
So when rates do shift down and since their asset have a higher rate it will grow faster than liabilities and now you have a surplus so active management kicks in.
That was my thought process and sometimes the questions do assume you pick up on stuff like that in other readings (which i think is what makes this test pretty hard)
Just because the bonds will have a higher market value
okay, seems we need to do two assumptions for this question…Thanks.
My issue with this problem is the word “switch” - if the port already using contingent immunization and the prevailing immunized rate of return exceeds the required rate than the portfolio is already being actively managed. I would think statement 2 is incorrect because when rates drop more of the portfolio could be actively managed but it’s not switched to active management.
I try not to over think this stuff but with CFA you never know how they are trying to trick you.
i agree the problem with the word “switch”. it is poor wording.