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

An immunized bond portfolio matches the present value and duration of a liability. Which risk remains most directly after a large non-parallel shift in the yield curve?

Convexity and yield-curve shape risk remain. Duration matching hedges only first-order exposure to small parallel yield shifts, so large or non-parallel moves can still change the portfolio and liability values differently. Rebalancing or key-rate duration matching is needed to manage this.

  1. AReinvestment risk is eliminated and nothing remains
  2. BConvexity or curve-shape risk, because duration matching only hedges small parallel shiftsCorrect
  3. CCredit risk is eliminated by matching duration
  4. DPrice risk is eliminated by matching only the coupon rates

Explanation

Duration matching hedges only first-order sensitivity to small parallel shifts. Large or non-parallel shifts expose the portfolio to convexity and curve-shape effects, so rebalancing and possibly cash-flow matching or key-rate matching are needed. Duration matching does not remove credit risk.

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