can anyone explain the difference between the 3rd and 4th extentions to classical immunization? they both seem to accept greater risk for the possibility of greater return. I have an idea what the difference may be, but I want to see what you guys come up with before I clue you into what I’m thinking. It looks to me like it may be just a subtle difference.
would you like to share ur views?
wow, I forgot about this one… let’s see what I remember from December:
both of these extentions deal with return maximization ( 1st and 2nd deal with risk minimization), however the 3rd extention deals more with immunizing the full portfolio, and the 4th deals more with immunizing a portion of the portfolio.
I believe the 3rd extention has to do with accepting a riskier immunized portfolio to acheive a substantially higher return. for example choosing between an immunized portfolio that has a 95% probability of acheiving at least a 7% return and an less well immunized portfolio that has a 90% chance of acheiving at least an 8.5%; an investor might choose the less well immunized portfolio for the opportunity to gain extra return. The whole portfolio is still placed in the immunization strategy, it may just be more or less well immunized depending on the return decision.
The fourth extention has to do with adding active return to the portfolio. In this extention you would immunize the portion of the portfolio needed to cover your liabilities and any extra (the cushion) would be invested in active management. The difference here would be that the immunized portion of the portfolio is just that, a portion; as in the entire portfolio is not used to immunize.
The material doesn’t seem to separate these two out from each other very well, at least to me. After reading this section a few times these are the differences I’ve come up with, although the book does not just come out and say “this is the third, and this is the fourth and here are the differences.” What do you guys think?