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CFA Level I · CFA Level I Exam · Interest Rate Risk and Return

An investor with a single liability due in seven years buys a fixed-rate bond portfolio and wants to immunize it against a one-time parallel shift in yields. Which condition is most likely required for the portfolio?

The portfolio's Macaulay duration should equal the seven-year horizon. Then price risk and coupon reinvestment risk offset after a one-time parallel yield shift. Matching maturity or modified duration to the horizon does not achieve this offset.

  1. AMacaulay duration equal to seven yearsCorrect
  2. BMaturity equal to seven years
  3. CModified duration equal to seven years

Explanation

Immunizing a single liability requires the Macaulay duration of the assets to equal the investment horizon. Under a parallel shift, price risk and reinvestment risk then offset. Matching maturity leaves price risk for coupon bonds, and modified duration is a different measure that is not equal to the horizon.

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