Contingent immunization

CFA Level III Fixed Income
#1

Choo is utilizing a contingent immunization (CI) approach to achieve better returns for the fund, so by his understanding of CI, he can use the entire fixed-income portfolio for active management until the portfolio drops below the safety net level or the terminal value.

Choo’s understanding of contingent immunization (CI) is:

  1. correct.
  2. incorrect, because CI does not use a terminal value.
  3. incorrect, because CI does not allow for active management

A is said to be the correct answer. Is it though? If portfolio drops below terminal value, does it necessarily mean active management should cease?

#2

you need to stop active management once portfolio value drops below safety net value.

the “or terminal value” part i believe is incorrect too. you use the terminal value to see what your portfolio would be worth based on the current interest rate environment, and then determine the safety net value (What your assets (portfolio) is worth based on interest rates environment less what your liabilities are worth based on same interest rate environment). If safety net value is below zero (which means PV(liabilities) is > PV(Assets) then you stop active management.

and so long as you are doing contingent immunization - you can use the entire portfolio.

#3

i think contingent immunization is viable as long as the portfolio is above safety net level. It means if the portfolio exceeds the guaranteed return, the manager can combine active investment with immunization. If the portfolio return is below the guaranteed return, the active management must stop.

#4

Yes, you need to stop active management; once your portfolio falls below the Safety Net Return. Then all the portfolio should be invested in the same Safety net return to cover your liability.

#5

I know that I need stop active management if portfolio falls below safety net level. I don’t understand why I need to stop active management when portfolio value falls below terminal value.

#6

Yes. So you agree that the answer CFAI are giving is wrong, right?

#7

I addressed this recently with my theory here: https://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91356828

I think it simply boils down to a poorly worded question.

#8

You don’t need to stop.

#9

Agree that the question is poorly worded.

Contingent immunization is only possible when the value of the portfolio is greater than the PV of the liabilities. As long as that’s the case, the portfolio value will be above the safety net level.