I’m sure many of you have your own notes but just wanted to share. This is CFAI’s one of the fave 5. Mostly from schweser and some CFAI. ****************************************** 1.Classical Single-Period Immunization: To immunize a portfolio’s target value or target yield against a change in the market yield, a manager must invest in a bond or a bond portfolio whose: a.duration is equal to the investment horizon and b.initial present value of all cash flows equals the present value of the future liability i.It assumes one-time instantaneous change in yields. ii.If portfolio duration < liability duration, the portfolio is exposed to reinvestment risk. (when rates are decreasing) iii.If portfolio duration > liability duration, the portfolio is exposed to price risk (when rates are increasing) 2.BUT, the duration changes because: a.The interest rates changes more than once b.Time passes. 3.Rebalancing: So, the portfolio must be rebalanced when the durations change. However: a.Frequent rebalancing increases transaction costs, reduces returns b.Less frequent rebalancing causes the duration wander from the target duration, which also reduces the likelihood of achieving returns. 4.Bond Characteristics to be considered in the portfolio: a.Credit rating: Default risk here b.Embedded options: Prepayment risk makes the duration difficult to forecast c.Liquidity: Makes rebalancing costly, decreases returns 5.Determining the target rate of return: a.The immunization target rate of return will always differ from the portfolio’s YTM unless the yield curve is flat: i.f the YC is upward sloping: Target return will be less than the YTM because of lower reinvestment risk. ii.If the YC is downward sloping: Target return will be greater than the YTM because of lower reinvestment risk 6.Discount Rate to find PVs: a.Using Treasury spot curve to discount the liabilities because it’s a more conservative estimate. b.A more realistic approach utilizes the yield curve implied by the securities held in the portfolio. 7.Immunization Risk: A measure of the relative extent to which the terminal value of an immunized portfolio a.No risk when zero coupon bonds are used. b.Low risk when cash flows concentrated around the horizon (bullet portfolio) c. Reinvestment and price risks will be high when the dispersion of cash flows around the horizon is high(barbell portfolio).
Thanks a lot for this, I believe you also have the quant part of this (related to calculating the cushion spread and the related terminal values etc.).
Wow…Thank you itstoohot. I was planning on doing a summary of this stuff. I’m sure it will be asked in one form or another.
gauravku Wrote: ------------------------------------------------------- > Thanks a lot for this, I believe you also have the > quant part of this (related to calculating the > cushion spread and the related terminal values > etc.). sorry dude only hard copy i have
gauravku Wrote: ------------------------------------------------------- > Thanks a lot for this, I believe you also have the > quant part of this (related to calculating the > cushion spread and the related terminal values > etc.). If I’m not mistaken, going by the LOS we aren’t responsible for those calcs. Will have to double check myself though.
Big Babbu Wrote: ------------------------------------------------------- > gauravku Wrote: > -------------------------------------------------- > ----- > > Thanks a lot for this, I believe you also have > the > > quant part of this (related to calculating the > > cushion spread and the related terminal values > > etc.). > > If I’m not mistaken, going by the LOS we aren’t > responsible for those calcs. > Will have to double check myself though. will check that, its good if we don’t have those crappy calcs.
Guess BB right. LOS says: “LOS27i. Discuss the extensions that have been made to classical immunization theory, including the introduction of contingent immunization”
Assume we trigger an immunization strategy after losing the spread cushion should interest rates move against us. what does this mean in practical terms ? we abandon active management but do we then switch into zero’s or adopt a passive management strategy and invest in pure bond index using optimization techniques ? Either way, aren’t we adding to transaction costs with a rebalancing of the remainder of the portfolio and eroding the return? Can someone provide a simple explanation ?
its, thank you so much! 5.Determining the target rate of return: a.The immunization target rate of return will always differ from the portfolio’s YTM unless the yield curve is flat: i.f the YC is upward sloping: Target return will be less than the YTM because of lower reinvestment risk. ii.If the YC is downward sloping: Target return will be greater than the YTM because of lower reinvestment risk can anybody explain this point for me? thanks