FI - R19 Liability Driven and Index Based Strategies

Question 1

Immunization

Answer 1

Immunization is the process of structuring and managing a fixed-income bond portfolio to minimize the variance in the realized rate of return over a known time horizon.

Question 2

Dispersion

Answer 2

Macaulay duration is the weighted average of the times to receipt of cash flow, dispersion is the weighted variance. it measures the extent to which the payments are spread out around the duration. (time in horizon - Macaulay duration of the portfolio)^2 * Macaulay weight of the time in horizon)

Question 3

Structural Risk

Answer 3

Structural risk arises from portfolio design, particularly the choice of the portfolio allocations. The risk is that yield curve twists and non-parallel shifts lead to changes in the cash flow yield that don not match the yield to maturity of the zero coupon bond that provides for the perfect immunization.
Structural risk is reduced by minimizing the dispersion of the bond positions, going from a barbell design to more of a bullet portfolio that concentrates the component bonds’ durations around the investment horizon.
At the limit, a zero coupon bond that matches the date of the single obligation has, by design, no structural risk.

Question 4

Accounting defeasance

Answer 4

It is a way of extinguishing a debt obligation by setting aside sufficient high quality securities, such as US T, to repay the liability

Question 5

Surplus

Answer 5

the difference between the mv of the assets and liabilities

Question 6

Tracking risk

Answer 6

Deviation of return on the selected portfolio from bond market index returns are referred to as tracking risk

Question 7

Tracking error

Answer 7

It is defined as the standard deviation of a portfolio’s activate return for a given period