Question

In: Finance

Compare and contrast the strategies of index matching (or indexing) and of immunisation for managing a...

Compare and contrast the strategies of index matching (or indexing) and of immunisation for managing a bond portfolio. Provide examples for who would use such strategies under what circumstances.

Solutions

Expert Solution

Bond management strategies:

  • Index bond strategy: this is considered to be quasi-passive by design. The main goal of this strategy is to provide a return & risk characteristic that is linked with the targeted index. It has the same flexibility of a passive buy & hold strategy but has some flexibility. Just like tracking a stock market index the bond portfolio can be structured to mimic any published bond index.

Because of the size of the index the strategy works well with large portfolio due to number of bonds that are required to replicate the index. One must also take into consideration the transaction costs that are associated not only with the original investment but also periodic balancing of portfolio to reflect the changes in the index. The strategy is primarily used by long term investors who want their returns to follow the market. Thus, investors usually have three choices when using an index strategy. They can choose a very narrow index that represents only a small portion of the market (such as the American Stock Exchange Biotech Index). Investors also can purchase a random sample of securities in an index (this is called a sampling approach) or they can purchase a set number of securities in each segment of an index (this is called a stratified approach).

  • Immunization strategy: this strategy has the features both passive & active strategies. Pure immunization implies that the investment is made for a defined return & for a specific period irrespective of the outside influences. The instruments that match with this strategy would include high grade bonds with remote chances of default.

This strategy is mainly used in institutional investment by insurance companies, pension funds & banks in order to match the time horizon of their future liabilities with structured cash flows. This is considered to be one of the soundest strategies & can also be used by the individuals.

For example, just like a pension fund would use an immunization to plan for cash flows upon an individual's retirement, that same individual could build a dedicated portfolio for their own retirement plan.


Related Solutions

In no more than 400 words, compare and contrast managing the supply chain, managing inventory, inventory...
In no more than 400 words, compare and contrast managing the supply chain, managing inventory, inventory models, and the nature of aggregate planning.
Explain why the neocortex is not able to function as an index by following the indexing...
Explain why the neocortex is not able to function as an index by following the indexing theory, give 3 reasons (hint: hippocampus indexing theory is a better fit) If NMDA receptors get knocked out of the hippocampus area, what will be the impact on both pattern completion and pattern separation according to the index theory?
What is the difference between qualitative and quantitative research sampling strategies? Compare and contrast the strategies...
What is the difference between qualitative and quantitative research sampling strategies? Compare and contrast the strategies and describe some of the advantages and disadvantages of each.
What is the difference between qualitative and quantitative research sampling strategies? Compare and contrast the strategies...
What is the difference between qualitative and quantitative research sampling strategies? Compare and contrast the strategies and describe some of the advantages and disadvantages of each.
What is the difference between qualitative and quantitative research sampling strategies? Compare and contrast the strategies...
What is the difference between qualitative and quantitative research sampling strategies? Compare and contrast the strategies and describe some of the advantages and disadvantages of each.
Compare and contrast replication strategies of (-) ssRNA and ssRNA-RT viruses.
Compare and contrast replication strategies of (-) ssRNA and ssRNA-RT viruses.
Compare and contrast the real effective exchange rate index and the nominal effective change rate index.
Compare and contrast the real effective exchange rate index and the nominal effective change rate index.
What are the various strategies utilized by Amazon and Walmart? Compare and contrast in order to...
What are the various strategies utilized by Amazon and Walmart? Compare and contrast in order to differentiate the strategies implemented by both companies. How do these differences affect their market valuations? Remember to post links and sources for your answer.
Volatility skew/smile and gamma are both volatility-oriented strategies. Compare and contrast the two trading strategies.
Volatility skew/smile and gamma are both volatility-oriented strategies. Compare and contrast the two trading strategies.
Compare and contrast the replication strategies of the following. a) Viruses and subviral entities b) Bacteriophages...
Compare and contrast the replication strategies of the following. a) Viruses and subviral entities b) Bacteriophages and eukaryotic viruses.
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT