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

A pension fund must pay a single liability of 10 million in 5 years. It buys a portfolio of bonds with PV equal to the liability and a duration of 5. Immediately afterward, yields fall in a parallel manner. Which statement best describes the immunized position over the next few periods?

Higher bond prices offset lower reinvestment income, but the position needs periodic rebalancing because asset duration and liability duration drift differently as time passes and yields change.

  1. ALower reinvestment income is offset by higher bond prices, but rebalancing is needed as duration drifts with time and yield changesCorrect
  2. BThe position stays immunized without any rebalancing because duration is constant
  3. CThe fund loses because price gains never offset reinvestment losses
  4. DThe fund gains because the liability value falls more than the assets

Explanation

Immunization offsets price and reinvestment effects, but asset and liability durations decline at different rates as time passes and yields change, so periodic rebalancing is required. Duration does not remain constant.

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