Reading 22 Exhibit 7 and Exhibit 8 -- Immunization

CFA Level III Fixed Income
#1

I’m trying to understand when immunization is possible.

Exhibit 7 on Page 60 shows how upward steepening/flattening or downward steepining/flattening can lead to the same results as a parallel shift in yield curves. Leads to immunization.

Exhibit 8 is where I’m confused. Do twists always lead to immunization not being achieved or is it only a risk?

For example, Exhibit 8, Part A (upper graph) of exhibit the losses on the long term position exceed the gains on the short term position. Isn’t it possible for this twist to lead to the same change in Market value for panel A on page 60 where it goes down by 11,340,212? And therefore it is immunized with the twist as well?

Thanks,

#2

Twist is a risk that makes Immunization impossible.

Immunization is only possible if you have parallel shift in curve.

#3

You can be immunized with a twist. I don’t agree with the previous post. The graph on exhibit 8 is not immunization though and occurs at time = 6. Look at exhibit 7. These are flattening and steeping examples where immunization happens.

I’ve noticed many people don’t respond to fixed income questions on this board. I’ve posted three questions and no responses. I think cause it’s a new topic these items are less discussed here.

#4

The major flaw of immunization is that it fails when the change in yield is not parralel. So twist will cause immunization to fail, and you will have to rebalance the portfolio by replacing some of the bond in the portfolio so as to attain immunization again.

People are not responding to Fixed Income because they have not covered it. I have covered Fixed Income, so I am talking from the position of knowledge.

Cheers.

#5

Olajidean

You’re talking about classical immunization which might not work for non-parallel shifts in YC. Since, in reality, YC changes are often non-parallel, according to your statement, immunization would never work and nobody would immunize portfolio which is not true. There are some modifyings of classical immunization strategy as key rate duration. Read carefully this chapter once again.

#6

Yes Flashback, you are correct, it simply skipped my mind to write about the use of Key Rate Duration for immunization.

Thanks for the highlight.