What is immunization of the balance sheet?
Immunization, also known as multi-period immunization, is a risk-mitigation strategy that matches the duration of assets and liabilities in order to minimize the impact of interest rates on net worth over time.
What is an immunized portfolio?
Immunization is a dedicated-portfolio strategy used to manage a portfolio with the goal of making it worth a specific amount at a certain point, usually to fund a future liability. Immunization is one of two kinds of dedicated-portfolio strategies (cash-flow matching is the other).
How do you immunize a portfolio?
In simple terms, to immunize a portfolio, we have to match the duration of portfolio assets with the duration of future liabilities. To understand, let us look into the tradeoff between price risk and reinvestment risk in the context of a fixed-income portfolio.
What is interest rate immunization strategy?
In finance, interest rate immunisation, as developed by Frank Redington is a strategy that ensures that a change in interest rates will not affect the value of a portfolio. Other types of financial risks, such as foreign exchange risk or stock market risk, can be immunised using similar strategies.
What is convexity and duration?
Duration and convexity are two tools used to manage the risk exposure of fixed-income investments. Duration measures the bond’s sensitivity to interest rate changes. Convexity relates to the interaction between a bond’s price and its yield as it experiences changes in interest rates.
What is the meaning of Macaulay duration?
The Macaulay duration is the weighted average term to maturity of the cash flows from a bond. The weight of each cash flow is determined by dividing the present value of the cash flow by the price. Macaulay duration is frequently used by portfolio managers who use an immunization strategy.
What is dynamic immunization?
A dynamic immunization strategy is a policy of portfolio selection that provides a rate of return that is at least as great as a ‘promised’ rate over a multi-period horizon.
How is Macaulay duration calculated?
The Macaulay duration is calculated by multiplying the time period by the periodic coupon payment and dividing the resulting value by 1 plus the periodic yield raised to the time to maturity.
What is key rate duration?
Key rate duration measures how the value of a debt security or a debt instrument portfolio, generally bonds, changes at a specific maturity point along the entirety of the yield curve.
How is convexity calculated?
As can be seen from the formula, Convexity is a function of the bond price, YTM (Yield to maturity), Time to maturity, and the sum of the cash flows. The number of coupon flows (cash flows) change the duration and hence the convexity of the bond.
