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Q11-8CP

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Essentials Of Investments
Found in: Page 366
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

Short Answer

The ability to immunize a bond portfolio is very desirable for bond portfolio managers in some instances.

a. Discuss the components of interest rate risk—that is, assuming a change in interest rates over time, explain the two risks faced by the holder of a bond.

b. Define immunization and discuss why a bond manager would immunize his or her portfolio.

c. Explain why a duration-matching strategy is a superior technique to a maturity matching strategy for the minimization of interest rate risk.

a. Price risk and reinvestment rate risks

b. Structuring of bond’s portfolio for reaching a target

c. Sensitivity of bond’s equal duration with equal rate fluctuation

See the step by step solution

Step by Step Solution

Explanation on components of interest rate risk ‘a’

Price risk and reinvestment rate risks are two risks where the former denotes volatility in the bond’s price on interest rate fluctuation, while the latter denotes the uncertainty at which rate the coupon can be re-invested.

Definition of immunization and explanation thereto

The process in which a bond’s portfolio is structured in such a manner that its value reaches a target irrespective of future rates fluctuation. Since this is a low-risk bond management strategy, bond managers would want to do this.

Explanation of decision matching strategy

It is because the bonds of equal duration are equally sensitive to the interest rate fluctuations. This is not true for equal maturity.

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