Using this contingent immunization question from the 2010 mock - can anyone explain to me what is actually happening with contingent immunization? A client of Frost, Farm Technology (FT), has entered into a transaction requiring a payment of USD 250,000,000 in two years. FT has USD 235,000,000 available to meet this liability. Frost recommends a technique called contingent immunization. Under certain market conditions, this technique can provide FT with a safety margin or cushion in meeting its liability. He notes that a U.S. government bond with a bond equivalent yield of 3.82% is available. FT agrees to implement contingent immunization using this bond. Something alongn the lines of They owe this liability payment in 2 years, and have $235MM cash now, and want to invest it in an asset that can enable them to meet the liability and invest the amoutn not required? How do they actually use a govt bond yielding 3.82%? Thanks!
if they need 250 Million in 2 years time and had invested in the 3.82% bond - how much would that liability be worth today ? (PV (Liab))?
= 250 / ((1+ (0.0382/2)^4) = 231.778316 Million.
They have 235 Mill - so cushion (initial) = 235 - 231.778716 = 3.221684 Mill .
This amount can be used for active management to increase returns.
Thanks bud. So when they say the yield on an asset/bond wtvr that is available to you, that is the imminuzation rate of return? (Not the required return to meet the FV of liabilities right?)
Isn’t the entire portfolio (not only cushion) actively managed?
I encountered such question and I got it wrong as I thougt that only the cushion is actively managed. It turned out that once the cushion is positive entire portfolio is actively managed, and once cushion declines to zero active mgmt is ceased.
yes entire portfolio is actively managed. as soon as cushion is zero, you have to switch to normal immunisation