SS10: Reading 22 Exhibit 5; Interest rate Immunization.
Why do we increase the bonds cashflow by the total return before the horizon date, yet after the horizon date we discount them back to that horizon date ?
The table is checking if the bond portfolio (assets) are sufficient to cover the EUR250 million liabilities due on 15 Feb 2023. This is why they bring the cash flows of the bond portfolio to this date by increasing or discounting.
One thing that I did not understand is why the value of 250,167,000 at 3.7608% is not between the 250,267,858 and 250,265,241 at 2.7608% and 4.7608% respectively. I ran the table and is not a rounding problem.
It will, if you sum up to 15-Feb-23 only. It’s about 92m, 95m and 98m for the three interest rates (2.7, 3.7, 4.7%) respectively.
The idea is to borrow remaining amount to 250m on 15-Feb-23 at current r, and repay using bond cash flows. Hence the discounting.
So they reinvest the CFs prior to horizon date (minus the amount due for that period) and after the horizon date (Duration Matched) they simply hold the cash until Time= 10 yrs?
Before horizon date - reinvest cash flows at current r until horizon date.
After horizon date - payoff the loan, pocket any excesses. What they do with the excesses is not in scope of this example since main idea is to repay the single liability at horizon date.
Sounds good to me if that’s all there is to it.