“…funds from a cash flow–matched portfolio must be available when (and usually before) each liability is due, because of the difficulty in perfect matching…”
Versus multiple liability immunization “MLI”
“…An immunized portfolio needs to meet the target value only on the date of each liability, because funding is achieved by a rebalanc- ing of the portfolio…”
Q: don’t the assets of the MLI also need to be ready to meet the liability due date? Why do they distinguish between a certain asset of the MLI and the cash from another asset from the CFMatching?
Well, while both strategies need to have cash flows at the liability date, how they get those cash flows differs. Cash flow matching means that you’ll have maturities and/or coupons paid out either soon before or at the liability date. Multiple immunization gets that cash from rebalancing the portfolio, offering it a lot more flexibility.
How do we do Cash flow matching? First we take a bond whose maturity should match with the last liability payment date & enough value putting Principal+Interest toghether to meet the liability amount. Subsequently we follow recursive order. If you see mainly we are matching EACH liability with EACH bond’s principal + coupon value to meet liability. Since perfect matching are difficult (i.e bond’s maturity & liability’s date at the same day) the funds has to be available either little before or on the day of liability date.
In MLI we meet the liability amount by rebalancing the portfolio. So we need funds (which can be from any of the bonds in the portfolio) to meet the target value on liability date
I would like to have other inputs to see if my understanding is right…
My tough time with this is the rebalancing that frees cash to meet liabilities…that’s where I can’t figure in practice how they do this.
If you say that they can sell each of the portfolio’s assets to meet the upcoming liability, won’t they have the same question of “dates”…
or what you’re telling me is that they can sell a bond from the portfolio exactly in the same date when the liability comes due? Sometimes is hard to put in practice so much theory without real examples.