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FRM Part II · FRM Exam Part II · Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques

A bank has a liability of 5,000,000 due in exactly 6 years and wants to immunize it with a portfolio of coupon bonds. Which condition, together with equal present value of assets and liabilities, is required for classical immunization against small parallel yield shifts?

The asset portfolio must have a duration equal to the liability's 6-year duration, along with equal present value. Then price changes and reinvestment effects offset for small parallel yield shifts. Zero duration or matching coupons does not achieve immunization.

  1. AAsset duration equals the 6-year liability durationCorrect
  2. BAsset duration is set to zero
  3. CAsset maturity is shorter than 6 years and convexity is zero
  4. DAsset coupon rate equals the liability's discount rate

Explanation

Classical immunization requires PV(assets) = PV(liabilities) and matching duration, so that price risk and reinvestment risk offset for small parallel shifts. A zero duration would not offset a liability with 6-year duration. Matching coupon rates is not the condition.

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