What is the relationship between Immunization and Dollar duration ? As time elapses or interest rates change, duration and dollar duration of portfolio changes. As dollar duration changes, depending on transactions costs, we need to decide if we want to reimmunize the portfolio as the previous immunization is insufficient. Is this correct ? Thank You
Is the objective of immunization to keep dollar duration constant to meet a constant liability ? So when ever dollar duration changes, we make additions / deletions to the portfolio to restore the dollar duration of the portfolio ? I am just trying to clarify my concepts. Thanks for your help.
From what I understand, we need to account for the change in market value along with the change in duration as we move in time. Dollar duration will help you rebalance your portfolio so that your composite duration equals the duration of your liability, thus you are immunized. This was not only the first section I read today, but the first section I read of the CFA text (basically getting back in the game). So I too would like to know what is the correct way of thinking about it.
Alright! Nibs is posting! Nice to see you back again…
Dollar duration is merely the method you use to immunize. For every asset and liability you can translate its duration to a dollar duration. That is quite an easy exercise. Then you decide what duration you’re looking for. If you’re looking for immunization you are looking for 0 duration so you have to hedge your entire dollar duration by the same negative dollar duration. In practice, that means going short in futures.
Dollar duration will change over time (with the change in Duration), and you may be asked how to rebalance this back to the original dollar duration amt. If so you need to find the rebalancing ratio (Old DD/ New DD). Subtract 1 from this then mutiply this to each bond in the current portfolio (current MV) - this will give the the $ amt you need to buy/ sell of each bond to bring the DD back in line. This can also be done by adjsuting one posn (a controlling posn), which is cheaper.
Welcome back, Niblita. GetSetGo, think of immunization as delta hedging of an option position.