Hi, in reading 20:Fixed-Income Portfolio Management - Part I
May I understand what does the following on ‘target return immunization’ mean:
A more realistic approach utilizes the yield curve (converted to spot rates) implied by the securities held in the portfolio. This yield curve can be obtained using a curve-fitting methodology. Because spreads may change as well as the term structure itself, the value of the liabilities will vary over time.
The return target immunization return is established by the actuary. Recall a balance sheet, it has both the assets (bonds invested in to generate a return to pay future liabilities) and liabilities (future obligations to be paid by the pension or insurance company). Now the actuary determines the present value of the liability by present valuing the future liabilities back by a discount rate. That discount rate is the target return. But this all assumes that the discount rate does not change or stays flat/constant over the future of the liabilities. Instead as it says above, a better or more realistic approach would be a curve fitting methodology whereby the discount rate changes to mirror the yield curve changing rate along the future liability horizon. A 1 year yield would be better matched up to discount a 1 year liability and so on rather than using one discount rate to use for all periods.
Marc A. LeFebvre, CFA
Founder & President - LevelUp, LLC and LevelUp BootCamps
wow thanks bootcamps for your kind clarification!
Absolutely…glad I could help. That material in Fixed income part I is a bit muddled at times.
-Marc