no, yield curve risk is different from interest rate risk. Interest rate risk is only parallel shifts AFAIK.
>if duration matches and PV matches, do we still exposed to interest rate risk yes or no? My answer is no Are you immunized against large parallel shifts too?
I think an immunized portfolio still has interest rate risk (due to large parallel movements and multiple parallel rate movements) but for purposes of the test I would think not.
Yes, you need to use very high credit quality for immunization. I remember reason about cap risk andknow what it is, but why does one use floatingrates in immunization in the first place? I can only think you might use them to lower duration and possibly pick up some yield through a spread analysis.
Does immunisation protect against both a shift in yield curve and change in shape (twist) or just the shift?
LOTTIE Wrote: ------------------------------------------------------- > Does immunisation protect against both a shift in > yield curve and change in shape (twist) or just > the shift? man, just the shift!!!
^^ but only for small parallel shifts and if it shifts multiple times you need to adjust the immunization.
Immunization protects against SMALL PARALLEL SHIFTS IN YIELD CURVE. If you have LARGE SHIFTS you are ONLY PROTECTED IF YOU MATCH CONVEXITIES TOO (and to the extent that convexity itself doesn’t have to be corrected, since it changes). The only way to get zero risk is to do cash flow matching with zero coupon treasuries. It’s also the most expensive. If you have a cash flow match (using non-treasuries), a default or call will mess things up and require rebalancing. Also, if you are using coupon bonds, it is impossible to do cash flow match and duration match simultaneously, so you will have interest rate risk if you have cash flow matching with coupon bonds.
chadwick good point, so there is still Interest Rate Risk?
“if duration matches and PV matches, do we still exposed to interest rate risk yes or no? My answer is no.” I think the CFA answer is “no, you are not exposed to interest rate risk” in reality, you are not protected against sudden large interest rate shifts. In CFAstan, however, you are continually adjusting the portfolio as interest rates change, and so you’ll be correcting the durations while they’re still small. Sort of like dynamic hedging. Remember that Interest Rate Risk is separate from Yield Curve Risk. Interest Rate Risk = Risk of Parallel Changes Yield Curve Risk = Risk of Perpendicular Changes (oops, read “yield curve twists”)
Same duration, same interest risk. That’s tested in Sample 3.
bchadwick Wrote: ------------------------------------------------------- > Immunization protects against SMALL PARALLEL > SHIFTS IN YIELD CURVE. If you have LARGE SHIFTS > you are ONLY PROTECTED IF YOU MATCH CONVEXITIES > TOO (and to the extent that convexity itself > doesn’t have to be corrected, since it changes). > > The only way to get zero risk is to do cash flow > matching with zero coupon treasuries. It’s also > the most expensive. > > > If you have a cash flow match (using > non-treasuries), a default or call will mess > things up and require rebalancing. Also, if you > are using coupon bonds, it is impossible to do > cash flow match and duration match simultaneously, > so you will have interest rate risk if you have > cash flow matching with coupon bonds. Cash flow matching can have no interest rate risk using coupon bonds. Extreme case is that you use a 10 year coupon bond to match a single liability due in 10 years, with the face value equal to the liability value. It’s a trade-off between cost and risk.
bchadwick Wrote: ------------------------------------------------------- > Immunization protects against SMALL PARALLEL > SHIFTS IN YIELD CURVE. If you have LARGE SHIFTS > you are ONLY PROTECTED IF YOU MATCH CONVEXITIES > TOO (and to the extent that convexity itself > doesn’t have to be corrected, since it changes). > > The only way to get zero risk is to do cash flow > matching with zero coupon treasuries. It’s also > the most expensive. > > > If you have a cash flow match (using > non-treasuries), a default or call will mess > things up and require rebalancing. Also, if you > are using coupon bonds, it is impossible to do > cash flow match and duration match simultaneously, > so you will have interest rate risk if you have > cash flow matching with coupon bonds. AWESOME SUMMARY!!! That said, did we agree that an Immunization STrategy using Single or Multiple Liability will completely eliminate Interest Rate Risk ie: Parallel shifts? I thought, as discussed, extremely large shifts, time and/or multiple shifts will make the immunization strategy fail unless rebalanced?
Can someone clarify what IR risk? I thought IR risk was made up of price risk and reinvestment risk. However, in the sample 3 exam it said although a portfolio of 6 yr and 10 yr duration has greater reinvestment risk as an 8 year liability, it has less interest rate risk?
AC123 Wrote: ------------------------------------------------------- > Can someone clarify what IR risk? I thought IR > risk was made up of price risk and reinvestment > risk. However, in the sample 3 exam it said > although a portfolio of 6 yr and 10 yr duration > has greater reinvestment risk as an 8 year > liability, it has less interest rate risk? They have the same price risk because they have the same duration. However, the barbell has more reinvestment risk, by which it will gain a higher return potential
That’s what I thought but answer key says both portfolio and liab have the same IR risk? How can that be if port has reinvestment risk and reinvestment risk + price risk = IR risk