Can someone please explain the difference between Cash Flow matching and Duration matching? I often find myself confused between these two.
Cash Flow Matching is an immunization approach in which a company has outstanding liabilities that need to be paid, so they structure their assets in a way so that they receive cash flows that match the amount of the liabilities that are due, when they are due. An example of this would be if they had zero coupon bonds that mature exactly on the day their liabilities are due, and in the amount that their liabilities are due.
This is not always possible though, because there may not always be zero coupon bonds available that match your exact liability needs. So instead what a portfolio manager would do is they would try to match the duration of the liabilities instead so that both the liabilities and the assets are affected similarly by a change in interest rates. This the Duration Matching approach to immunization.
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