9.43 Immunization: “Duration Matching”
- As interest rates fall, reinvestment rates fall.
- As interest rates fall, price rises.
- Cash flow matching may, at times, be impossible due to limits on bond selection, therefore immunization strategies may be implemented.
- Duration is the measure of time where interest-on-interest will exactly offset any capital gain/loss, such that any decrease/increase in reinvestment is offset by price increase/decrease.
- Immunization involves matching the duration of one’s assets with the liabilities.
- Because Duration changes daily (i.e., with the mere passage of time) portfolios must be re-balanced at pre-determined intervals.
