What is a portfolio immunization?
A portfolio immunization refers to matching assets and liabilities (cash flows) in a way to mitigate interest rate risks. The immunization strategy generally refers to a fixed-income portfolio that is created to offset liabilities in a certain period.
What is an immunization in a fixed-income portfolio?
Classical immunization can be defined as the process by which a bond portfolio is created to have an assured return for a specific time horizon irrespective of interest rate changes. That is, immunization offsets interest rate risk and reinvestment risk.
What is interest rate immunization?
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 classical immunization?
Classic immunization can be defined as the creation of a fixed-income portfolio that produces an assured return for a set period, regardless of parallel shifts in the yield curve.
What process is used to perform portfolio immunization?
Immunization is a risk-mitigation strategy that matches asset and liability duration so portfolio values are protected against interest rate changes. Immunization can be accomplished by cash flow matching, duration matching, convexity matching, and trading forwards, futures, and options on bonds.
What is reinvestment rate risk?
Reinvestment risk refers to the possibility that an investor will be unable to reinvest cash flows received from an investment, such as coupon payments or interest, at a rate comparable to their current rate of return. This new rate is called the reinvestment rate.
What is contingent bond portfolio immunization?
Contingent immunization. An arrangement in which the money manager pursues an active bond portfolio strategy until an adverse investment experience drives the then-available potential return down to the safety net level.
Why do investors want to immunize your portfolio?
Immunization helps large firms and institutions protect their portfolios from exposure to interest rate fluctuations. Using a perfect immunization strategy, firms can nearly guarantee that movements in interest rates will have virtually no impact on the value of their portfolios.
How is reinvestment calculated?
Divide the company’s capital expenditures by the net income to determine the reinvestment rate. For example, if a company has $100,000 in net income and $50,000 in capital expenditures, the reinvestment rate is equal to $50,000/$100,000 = 50%.
What is reinvestment risk example?
Understanding Reinvestment Risk For example, an investor buys a 10-year $100,000 Treasury note (T-note) with an interest rate of 6%. The investor expects to earn $6,000 per year from the security. If the investor buys another bond with the $6,000 received, they would receive only $240 annually rather than $360.
How do you immunize a portfolio?
Key Takeaways
- Immunization is a risk-mitigation strategy that matches asset and liability duration so portfolio values are protected against interest rate changes.
- Immunization can be accomplished by cash flow matching, duration matching, convexity matching, and trading forwards, futures, and options on bonds.