2010 AM mock for level 3 states in question 6C: liabilities should NOT be discounted using the zero coupon bond, they should be discounted by the IRR on the immunised portfolio. Volume 2 reading 15, end of curriculum question 4 reads: “pension liabilities are long term. the discount rate used to discount pension liabilities is the rate at which high quality bond such as the long treasury bond are quoted”. Isn’t this contradictory?
Treasury bonds is not equal to zero coupon. The discount rate used to find PV of liabilities should be based on the yield of bonds with similar maturities.
Thanks g3r41d. what’s puzzling me is the use of IRR of the immunisation. I get that ZCB aren’t the same as treasuries
I guess what it means is to discount liabilities using the currently available immunization rate (IRR) which in fact is typically the treasury YTM.
another thing that’s confusing me… just gone throug reading 25 and answer 28 of EOC states 5year ZCB are best to immunise the hospital liability… (vs 5year euro coupon bonds) am I losing the plot?!?
Zcb will always be better than the euro coupon bond since there are no intermediate cash flows and the full principal is realized at maturity.
for immunization the hierarchy of bonds to use is ZCB followed by BULLETS followed by BARBELLS
I disagree with that statement - ZCB’s will have a lower YTM than coupon bonds - which means you will require a larger cash outlay to fund the liabilities than a properly immunized bullet or barbell.
I don’t think it’s right to assume that ZCB’s are always the first in hierarchy for immunization…
That being said, if the objective is to be risk-minimizing and you have sufficient cash to use the ZCB’s, then yes they would be the best choice. If your objective is return-maximizing, then it’s not the right choice.
Well… If I were to choose, I’d pick ZCB for an immunization, since you’re not facing reinvestment risk if the curve is upward sloping as is normally the case. the issue is that there is a discrepancy in what CFA says: - 2010 AM says “do not use ZCB, use internal rate of return to discount your immunised liabilities” - volume 4 reading 25 2013 eoc question 28 says “use ZCB” - Volume 2 reading 15, end of curriculum question 4 reads: “pension liabilities are long term. the discount rate used to discount pension liabilities is the rate at which high quality bond such as the long treasury bond are quoted”.
In my post above - I don’t mean which rate to use to discount - I actually mean which securities to use for the immunization strategy itself - just to avoid any confusion.
double post? I guess you dont beileve me 
http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91321962
it is good to do some due diligence.
Hi summerside182, thanks! I thought that post did not go through, so yep… here’s a duplicate! sorry about this And thanks for thé explanation