Question

.   Explain what passive bond portfolio management is and how immunization and dedication can work when using a passive strategy. Please be as specific and complete as possible. (10 pts.)

Answer 1

Passive bond management strategies involve setting up a bond with specific characteristics that can achieve investment goals without altering the strategy before maturity. The primary passive strategies are index matching, cash flow matching, and immunization.

Immunization is a strategy which involves matching the duration of the assets with the duration of the liabilities , minimizing the impact of interest rate. Immunization can be achieved by cash flow matching, duration matching and so on.

In case of passive strategy , immunization is used to protect the portfolio from external influences like changes in interest rate. Immunization when combined with passive strategy involves giving up active return . For eg:- using duration matching to immunize the passive portfolio. To immunize using duration matching, we must match the portfolio's duration to the investment time horizon. If the portfolio has $10,000 obligation in 5 years , then to immunize we can buy a zero coupon bond maturing in 5 years and equals $10,000.

It is also possible to make profit in duration matching , by having a higher convexity of the asset than the liabilities.