Could someone explain the difference between target immunization rate and the safety net return? Thanks
a) One is a return level the other is a rate level.
b) Target Immunization Rate is what the Portfolio manager understands can be achieved and decides to achieve. E.g. He wants to achieve a 3% return on his assets.
c) If he achieves that rate of return - and the external interest rate environment remains unchanged - his assets would achieve X (Original Value) * (1+Target Return)^T.
d) If the external rate environment is r% -> LIability Needed / (1+r)^t would be the Present Value of liabilities.
e) If his Asset Portfolio Value (Value in c) is GREATER THAN Value of his Liabilities needed (d) --> c - d = Safety Net return.
I hope I got that right!
Gotcha! Thanks CPK123
So
Immunization Rate is the Market Rate (YTM) and it may change with time while the
Safety Net Return is the Required Return on the Liability which is fixed ?
no.
Thx for your feedback. appreciate if you elaborate if there this doesnt bother u
Read the couple of examples in the book, should make things clear.
Look at the white area right under the first example (also in the white area).
you need to understand this - when the rates move - Assets remain the same, but liabilities change.
Assets:
If he achieves that rate of return - his assets would achieve X (Original Value) * (1+Target Return)^T.
What would the liabilities be worth?
Today => Liability Needed / (1+r)^t would be the Present Value of liabilities (Where r = Current rate environment)
With this - your safety net return = Assets - PV(Liabs).
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If r (external rates) change to r’ e.g.
PV(Liabilities) New = Liability Needed / (1+r’)^t
and Safety Net Return = Assets - PV(Liabs) NEW