Known also as multi-period immunization, immunity is a risk-mitigation approach in which the duration of assets and liabilities are matched in order to reduce the effect of interest rates on net worth as time progresses.
What is ‘Immunization’
Immunization, sometimes known as “multiperiod immunization,” is a financial technique in which the durations of assets and obligations are matched, therefore limiting the influence of interest rates on a company’s overall net value.
In order to shield their portfolios from exposure to interest rate swings, large corporations and institutions might use what is known as an immunization strategy. With the use of a flawless immunization strategy, companies can practically ensure that changes in interest rates will have little or no influence on the value of their portfolios in the long run.
Cash Flow Matching Immunization Example
Assume that an investor has a $10,000 commitment that must be met within five years. For the purpose of protecting themselves against this certain cash loss, investors might acquire a security that guarantees a $10,000 inflow within five years. A zero-coupon bond with a maturity of five years and a redemption value of $10,000 would be appropriate. Through the purchase of this bond, the investor ensures that the projected inflow and outflow of funds are balanced, and any change in interest rates will not have an impact on his capacity to meet the obligation in five years’ time.
Duration Matching Immunization Example
When employing the duration approach to immunize a bond portfolio, an investor must ensure that the length of the portfolio corresponds to the investing time horizon in question. If an investor has a $10,000 commitment that will be due in five years, he may utilize duration matching in a variety of ways, including:
- In the first instance, an investor may acquire a zero-coupon bond with a maturation of five years and a face value of $10,000.
- Second, an investor may acquire a number of coupon bonds, each with a five-year period and a total value of $10,000, in a single transaction.
- Third, when taken as a whole, an investor may acquire a number of coupon bonds totaling $10,000 that have an average term of five years when regarded as a whole.
What does it mean to immunize a portfolio?
Put another way, to immunize a portfolio, we must ensure that the duration of portfolio assets is equal to or greater than that of future obligations. Let us examine the tradeoff between price risk and reinvestment risk in the context of a fixed-income portfolio in order to have a better understanding.
What is contingent immunization strategy?
Continuous immunization is an investing technique in which a fund management changes from his or her aggressive strategy when the portfolio return falls below a specified threshold level. An active management strategy is one in which a fund manager employs an active management method to personally choose stocks in the hopes of exceeding a benchmark index.
What is the basic underlying principle in an immunization strategy?
Fundamental to immunization is the construction of a portfolio that strikes a balance between the change in value of a portfolio at the end of an investment horizon and the rate of return from the reinvestment of portfolio cash flows over an extended period of time (both coupon and principal payments).
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