The manager of a bond portfolio must immunize the portfolio with respect to a given set of liabilities. The manager is choosing between two immunization strategies: Strategy A and Strategy B. Strategy A has a lower return, lower risk, and a 99% probability of providing the required return to meet the given set of liabilities. The manager should choose Strategy B:
A) under no circumstances, because risk minimization is the point of immunization. B) if that strategy’s higher risk is justified by the higher return, and the probability of meeting the liabilities is equal to or only slightly lower than that of Strategy A. C) if that strategy’s higher risk is justified by the higher return, and only if the probability of meeting the liabilities is equal to or higher than that of Strategy A.
Wwhere is this question from? If the probability of meeting the required return is the same then obviously one would go for the efficient portfolio. But probability and risk go hand in hand. I am not sure about the validity of this question.
if a substantial increase in return can be achieved with little effect on immunization risk, the higer yielding portfolio may be prefeered inspite of higher risk.
This is a good point, now I’m not as sure of my answer.
after reading this example again, it doesn’t mention confidence (probability) increasing or decreasing, only risk increasing. In the book example the confidence band stays the same at 95%, but the probability of attaining their 8% needed return increases because the greater return overcompensates for the increased risk. I think this could have been written up better in the book to be a little more clear, the answer could possibly be C from this point of view.