Foundations Foundationsof ofFinance: Finance: Bond BondPortfolio PortfolioManagement Management

Prof. Alex Shapiro

I. Readings and Suggested Practice Problems

Lecture Notes 13 BKM, Chapter 1 , Sections 1 .1!1 ."

Bond Portfolio Management

Suggested Pro#lems, Chapter 1 : 1 !1$.

I.

II. Risks Associated wit !efault"#ree Bonds III. !uration$ !etails and %&am'les Bonds II. Risks Associated wit !efault"#ree I(. Immuni)ation
'( Reinvestment Risk

%!mail: &pen the Bond Immunization program to generate the Readings and Suggested Practice Problems examples in Section '(, and to construct )our o*n examples of target!date immuni+ation.

'f an indi,idual has a particular time hori+on T and holds an instrument *ith a fixed cash flo* recei,ed prior to T , then the in,estor faces uncertaint) a#out *hat )ields *ill pre,ail at the time ofRate the cash flo*. -his uncertaint) is .no*n as Buzz Words: Interest Risk, Reinvestment Risk, Liquidation reinvestment risk . Duration, Modified Duration, Risk, Macaulay Convexity, ar!et"Date Immunization, #et"Wort$ Immunization, Duration %a& )xam&le Suppose an in,estor has to meet an o#ligation of /0M in t*o )ears time. 'f she #u)s a t*o )ear coupon #ond to meet this o#ligation, there is uncertaint) a#out the rate at *hich the coupons on the #ond can #e in,ested. -his uncertaint) is an example of rein,estment ris..
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Foundations of Finance: Bond Portfolio Management

B( Liquidation *+rice, Risk 'f an indi,idual has a particular time hori+on T and holds an instrument *hich generates cash flo*s that are recei,ed after T , then the in,estor faces uncertaint) a#out the price of the instrument at time T . -his uncertaint) is .no*n as li2uidation ris..

)xam&le Suppose an investor has to meet an obligation of $5M in two years time. If she buys a five year dis ount bond to meet this obligation! there is un ertainty about the pri e at whi h this bond will sell in two years time. This un ertainty is an e"ample of li#uidation risk.

C( -ield C$an!es and +rice C$an!es 1. 'f a #ond sells at a premium or discount, its price *ill con,erge to par, e,en if the 3-M y sta)s constant. 4-his price change is e"pe ted , and is not normall) considered ris..5 1. 6nexpected #ond price changes *ill occur if mar.et interest rates changes unexpectedl). -his is interest rate risk , *hich causes the rein,estment ris. and li2uidation ris.7 't affects the rate at *hich coupon pa)ments can #e rein,ested, and affects the price at *hich a #ond can #e sold 4prior to maturit)5.
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Foundations of Finance: Bond Portfolio Management

)xam&le Price path of a /188!par +ero that matures in )ear 18 Price path if y 90: for 18 )ears

/118.88 /188.88 /$8.88 / 8.88 /;8.88 /18.88 /8.88 81; $18 *ime
6nexpected price drop ". Can examine the plots of price $of an) #ond as a function of the 3-M, y , using the follo*ing functional relation:
$9
T t 91 t

Price path if y unexpected shifts to 18: in )ear ".

%&t 41 < y 5

'f )ou .no* ho* y affects $ , )ou can tell ho* affects portfolios of #onds, and can decide ho* to manage )our #ond portfolio gi,en )our o#=ecti,es.
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Foundations of Finance: Bond Portfolio Management

$ (

d$ dy

y '

1 d1 $ 1 dy1

4 y 51 < >

?i,ide #) $ :
$ $

1 d$ $ dy

y' y< y<

1 1

1 1 d1 $ 1 $ dy1

4 y 51 < > 4 y 51 < > 4 y 51 < >

9 ! 9 !

)@
) 1< y

4 %onve"ity 5
1 1

4 %onve"ity 5

A second order approximation for the impact of )ield changes is therefore 4using the definitions for )@ and %onve"ity gi,en #elo*5:
$ $

!)@

y<

1 1

4 %onve"ity 5

4 y 51

A first order approximation 4a linear, and less precise one5 is:

$ $

!)@

y ( !

) 1< y

y ( !)

41 < y 5 1< y

*ith the )uration 4 ) 5, the Modified )uration defined as: )@ 41 < y 5 9 !

1 d$ $ dy
T t 91

4 )@ 5, and %onve"ity

) 9

41 < y 5 9

tC

%&t B 41 < y5t $

)@ 9 ) B 41 < y 5 %onve"ity 9
1 d1 $ $ dy1

$ 41 < y 5 1

T t9 t1

%&t 4t

<t5

41< y 5

Foundations of Finance: Bond Portfolio Management

III. !uration$ !etails and %&am'les

-o understand the important features of managing fixed income portfolios, *e *ill focus on the simpler, first*order appro"imation to the impact of )ield changes on prices.

'( Duration ?uration 4the ) defined a#o,e is Macaula)Ds first measure of duration5 is used to measure the price ris. of a #ond 4i.e., interest rate sensiti,it)5. ?uration relates the change in a #ond price 4 associated change in the #ondDs 3-M 4 y 5. $ 5 to the

?uration is omputed as the effecti,e 4*eighted a,erage5 maturit) of the #ond. 4-his is distinct from the nominal maturit) of the #ond.5

B(

$e &rice c$an!e caused .y a !iven c$an!e in - M: ' vs( + -he lin. #et*een maturit) and price ris. is easiest to demonstrate for a +ero: )xam&le 10!)ear +ero, /188 par, y 9 $:

p 9 $+ 4188, $:, 105 9 "1.01;1

Foundations of Finance: Bond Portfolio Management

Suppose *e ha,e a small change in 4E y drops #) one #asis pointF5.

y : y 9 !.81: 9 !8.8881

p 9 $+ 4188, G.HH:, 105 9 "1.0 $8 p 9 "1.0 $8 ! "1.01;1 9 8.8;"$ &ne *a) to relate p and y is to compute

Proportion al change in p Proportion al change in 45 1< y

p 8.8;"$ p 8.881"$H ! 9 ! "1.01;1 9 9 10 9 M 4the maturit)5 45 1< y ! 8.8881 8.8888H1 45 1< y 1.8$ -he example illustrates that for a +ero coupon #ond, *e can estimate its relati,e price change 4for a gi,en change in y 5 #):

p p
For an) #ond :

A !MC

45 1< y 45 1< y

45 p 1< y A ! )C 45 p 1< y
*here ) is the duration of the #ond, and
G

y is the 3-M.

Foundations of Finance: Bond Portfolio Management

C( Com&utin! t$e Duration for /eros 0or a zero"cou&on .ond : ) ( M 4the stated maturit)5 : ) 9 the *eighted a,erage

0or a &ortfolio of t1o zeros maturit) of the t*o +eros:

)$ ( w , ), ' w - )*here the *eights, w Ds, are mar.et!,alue *eights.

)xam&le y 9 18: Bond 1 is a 0!)r, 188 par +ero, $1 9 1.8H Bond 1 is a 18!)r, 188 par +ero, $1 9"$.00 -he total ,alue of the portfolio is 188. ;

) 9
$

1 .8H "$ .00 0< 18 188 . ; 188 . ;

9 8. 1C0 < 8."$C18 9 .H )ears

)xercise: ,erif) that if 1< y goes to 1.181, the ,alue of the portfolio changes #) ! .H 41< y 5B41< y 5

Foundations of Finance: Bond Portfolio Management

D(

$e Duration of a Cou&on Bond A coupon #ond is simpl) a portfolio of +eros. Iet %& t 9 coupon and principal pa)ments in )ear t 9 1,> T 4the #ondDs maturit)5. -hen ) 9 w1 C1< w1 C1< . . .< wT C T *here the wDs are the mar.et ,alue *eights:
w $+ 9 << %& y t t $+ %& 4,,5 y 4 ,,5 $+ %& 1 yK T
1

t , for

4 5 t ,,
T

%& 99< Bond $ri e

4 5yt4t,,5 $+ %&

t t

Bond $ri e

Duration of a cou&on .ond: t$e 23eesa14

y 9 $:.

) of the G: #ond

9 0. )ears7 for the 1;:,

H

) 90.8 )ears.

Foundations of Finance: Bond Portfolio Management

)( 3$ortcut Duration 0ormulas

1 For a perpetuit), ) 9 y<

1 T For a le,el annuit) *ith end dateT) , y9 < ! <! y 411 5 yT

4 5 4yT 5y 11 For a coupon #ond *ith coupon rate ) , y 9 < ! << ! y y4 11 y5 <!< T

JK

'f ,y99< 4#ond ) y ! <sells at par5,

111 yy

415

0( Related Measures 1. A#o,e defined the Macaula)Ds ?uration Measure: PBP 9 ! ? C )B41<)5 9 ! ? C 41< )5B41<)5

1. ?B41<)5 is called

modified duration : C )

PBP 9 ! 4modified duration5

". 4P

C?5B41<)5 is called P 9 ! 4dollar duration5

dollar duration : C )

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Foundations of Finance: Bond Portfolio Management

I(. Immuni)ation
. portfolio is immunized when it is /unaffe ted0 by interest rate hanges. A. *arget !ate Immuni)ation
Consider an institution or in,estor that needs to meet future fixed o#ligations. ar!et date immunization ensures that a stream of fixed outflo*s can #e met from a,aila#le assets. -his is ac$ieved #) holding a portfolio of fixed income assets, *ith the same current ,alue as the lia#ilit) stream, and *ith the same 4modified5 duration.

5( Immunization 1$en a lia.ility is a sin!le cas$ flo1

&or illustration assume L the )ield cur,e is flat at

an) shift in the cur,e .eeps it flat.

1iven the flat yield urve! all bonds have the same 2TM! y. a. For this reason, a small shift in the )ield cur,e *ill ha,e the same effect on the current ,alue of the immuni+ing assets and on the current ,alue of the lia#ilities 4using the definition of duration5, and so the assets *ill still #e sufficient to meet the stream of fixed outflo*s at the target date4s5. #. %2uating the 4modified5 durations of the assets and the is the same as e2uating the durations.
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lia#ilities

Foundations of Finance: Bond Portfolio Management

)xam&le 5 Consider the ,alue of a #ond portfolio consisting of one G!)ear annual coupon #ond: the portfolio value 9 < value of the reinvested oupons the market pri e of the bond .

Consider the case of y ( 18: 4Scenario '5, and also consider an une"pe ted in rease in y 4Scenario ''5, *here y =umps from 18: to 11: immediatel) after purchase:

Bond 'o rtfolio ,alue o,er time. Bond - aracteristics$ -ou'o n$ 1..3/0 Par$ 11///.// Maturit+$ 2 *ime /1334.52 Maturit+ -ou'on Princi'al Scenario I$ 6*M !uration Bond Price Rein, -'ns *otal Scenario II$ 6*M !uration Bond Price Rein, -'ns *otal $ II"I G 0;"118 10".88 10".88 10".88 10".88 10".88 10".88 10".88 1,888.88 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 0.88 ;.08 ".H; "."" 1. ; 1.$G 1.88 1,10$.8" 1,1"8.$" 1,188.H1 1,1 $.88 1,1"1.$8 1,8H1.H$ 1,8;$.1$ 1,888.88 10".88 "11."8 08 .;" G18.8G H";.8$ 1,1$8.;H 1,;01.0; 1,10$.8" 1,"$".$" 1,011.11 1, G;.;" 1,$;1.$$ 1,81 .8 1,11$. G 1,;01.0; 11.88: 11.88: 11.88: 11.88: 11.88: 11.88: 11.88: ;.H0 ;.;G ".H1 "."1 1. ; 1.$G 1.88 1,181. 1 1,1$1.H1 1,10$.H1 1,1"".;1 1,180.8$ 1,8G". ; 1,8"$.G; 1,888.88 10".88 "11.$" 011."; G18.0H H01.$0 1,118. G 1,;H .$; 1,181. 1 1,"";.H1 1,;$1.G0 1, ;;.G0 1,$10. G 1,81 .;H 1,1;H.;1 1,;H .$; !00.;8 !;$.H1 !;8.; !1H. H !1 .11 8.;" 18.G; ;0."8

)oes the shift help us or hurt us3 It depends on our investment horizon4

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Foundations of Finance: Bond Portfolio Management

'n unex&ected decrease in y

$ Mere, y goes from 18: to H:

Bond 'ortfolio ,alue o,er time. Bond - aracteristics$ -ou'on$ 1..3/0 Par$ 11///.// Maturit+$ 2 *ime /1334.52 Maturit+ -ou'on Princi'al Scenario I$ 6*M !uration Bond Price Rein, -'ns *otal Scenario II$ 6*M !uration Bond Price Rein, -'ns *otal $ II"I

G 0;"118 10".88 10".88 10".88 10".88 10".88 10".88 10".88 1,888.88 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 0.88 ;.08 ".H; "."" 1. ; 1.$G 1.88 1,10$.8" 1,1"8.$" 1,188.H1 1,1 $.88 1,1"1.$8 1,8H1.H$ 1,8;$.1$ 1,888.88 10".88 "11."8 08 .;" G18.8G H";.8$ 1,1$8.;H 1,;01.0; 1,10$.8" 1,"$".$" 1,011.11 1, G;.;" 1,$;1.$$ 1,81 .8 1,11$. G 1,;01.0; H.88: H.88: H.88: H.88: H.88: H.88: H.88: 0.80 ;.0" ".H "."; 1. 0 1.$G 1.88 1,"1G.8$ 1,1$1. 1 1,1;0.80 1,18;.18 1,10H.;G 1,118.$1 1,80G.$8 1,888.88 10".88 "1H.GG 081.00 HH. H H10. 1,101.8G 1,;8G. G 1,"1G.8$ 1,;"0. 1 1,0 ;.$1 1,G80. 0 1,$0H.1 1,81 .;$ 1,18$.$G 1,;8G. G 0H.80 01.G$ ;1. 1 "1.11 1G.1$ 8.;1 !1H.$8 !;".$G

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Foundations of Finance: Bond Portfolio Management

&rom the tables we see that5 L 0 )ears is the duration of the #ond at time 8. L At )ear 0, *hether y goes up or do*n, our portfolio ,alue suffers onl) a minor change in ,alue.

6ow an we use this for immunization3 L At time +ero, if *e set the duration e2ual to the target date 4a point at *hich *e must fund some .no*n o#ligation, e.g., /1,81 in 0 )ears5, and if *e set the #ondDs future ,alue at the target date e2ual to the amount of the o#ligation 4i.e., the #ondDs current ,alue e2ual to the current ,alue of the o#ligation5, then *e are not greatl) affected #) changes in y . L 'n general, as long as target date 9 duration, and current ,alue of assets 9 current ,alue of lia#ilities, *e are said to #e immunized( L 'n the example, the portfolio ,alue at time +ero has the same ,alue as a 0 )ear +ero *ith par 1,81 .8 and has the same 4modified5 duration as a 0 )ear +ero. Mence, changes in y affect the portfolio ,alue similarl) to their effect on the a#o,e +ero, and therefore the portfolioDs 0 )ear future ,alue remains similar to +eroDs par 41,81 5. L -arget date immuni+ation is fre2uentl) practiced #) pension funds and insurance companies. L Nhen the assetsD duration is not matched to the target duration of the lia#ilities, *e ha,e a E?uration Oap.F
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Foundations of Finance: Bond Portfolio Management

Lar!e c$an!es in y $'mmuni+ation is onl) approximate. As the changes in y get larger, the 2ualit) of the approximation deteriorates. MereDs a large decrease:
Bond 'ortfolio ,alue o,er time. Bond - aracteristics$ -ou'on$ 1..3/0 Par$ 11///.// Maturit+$ 2 *ime /1334.52 Maturit+ -ou'on Princi'al Scenario I$ 6*M !uration Bond Price Rein, -'ns *otal Scenario II$ 6*M !uration Bond Price Rein, -'ns *otal $ II"I

G 0;"118 10".88 10".88 10".88 10".88 10".88 10".88 10".88 1,888.88 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 0.88 ;.08 ".H; "."" 1. ; 1.$G 1.88 1,10$.8" 1,1"8.$" 1,188.H1 1,1 $.88 1,1"1.$8 1,8H1.H$ 1,8;$.1$ 1,888.88 10".88 "11."8 08 .;" G18.8G H";.8$ 1,1$8.;H 1,;01.0; 1,10$.8" 1,"$".$" 1,011.11 1, G;.;" 1,$;1.$$ 1,81 .8 1,11$. G 1,;01.0; 1.88: 1.88: 1.88: 1.88: 1.88: 1.88: 1.88: 0.;1 ;.GG ;.11 ".;1 1. $ 1.$$ 1.88 1,H 1.1" 1,$1$.G0 1, H;.8; 1,00G.H$ 1,;18.0 1,1$1.GG 1,1;1.0$ 1,888.88 10".88 "8G.0" ; ". 1 11.1; G$8.;0 H;1.1 1,18". G 1,H 1.1" 1,H$1.G0 1,881.0G 1,811.0H 1,8;1.$8 1,8 1.11 1,8$1.$; 1,18". G G8;.11 0HG.H1 ;GH." ";G.10 1HH.H" " .1 !1;0.$" !";G.$G

MereDs a large increase:

Bond 'ortfolio ,alue o,er time. Bond - aracteristics$ -ou'on$ 1..3/0 Par$ 11///.// Maturit+$ 2 *ime /1334.52 Maturit+ -ou'on Princi'al Scenario I$ 6*M !uration Bond Price Rein, -'ns *otal Scenario II$ 6*M !uration Bond Price Rein, -'ns *otal $ II"I

G 0;"118 10".88 10".88 10".88 10".88 10".88 10".88 10".88 1,888.88 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 0.88 ;.08 ".H; "."" 1. ; 1.$G 1.88 1,10$.8" 1,1"8.$" 1,188.H1 1,1 $.88 1,1"1.$8 1,8H1.H$ 1,8;$.1$ 1,888.88 10".88 "11."8 08 .;" G18.8G H";.8$ 1,1$8.;H 1,;01.0; 1,10$.8" 1,"$".$" 1,011.11 1, G;.;" 1,$;1.$$ 1,81 .8 1,11$. G 1,;01.0; 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: ;.0; ;.1$ ".G; ".11 1. 8 1.$ 1.88 $"8.0$ $;".G8 $0H.;; $G$."" H81.88 H1$.1H H 8.$" 1,888.88 10".88 "" . 8 00 .H1 $11."8 1,1"$.0 1,01H.1$ 1,HG .1" $"8.0$ HH .G8 1,1H .8; 1,;"0.10 1,G11."8 1,8 .G 1,;$8.11 1,HG .1" !;1G.;; !"$G.1" !"1 .1G !1"H.1$ !11H.0$ ;8.G8 101.;; 01;. 8

10

Foundations of Finance: Bond Portfolio Management

6( Immunization of a sin!le cas$ flo1 over time -o no*, *eD,e assumed that the y occurred immediatel). Suppose that y goes to 11: at the end of )ear " 4i.e., it is applica#le for )ear ; and #e)ond5.

Bond 'ortfolio ,alue o,er time. Bond - aracteristics$ -ou'on$ 1..3/0 Par$ 11///.// Maturit+$ 2 *ime /1334.52 Maturit+ -ou'on Princi'al Scenario I$ 6*M !uration Bond Price Rein, -'ns *otal Scenario II$ 6*M !uration Bond Price Rein, -'ns *otal $ II"I

G 0;"118 10".88 10".88 10".88 10".88 10".88 10".88 10".88 1,888.88 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 18.88: 0.88 ;.08 ".H; "."" 1. ; 1.$G 1.88 1,10$.8" 1,1"8.$" 1,188.H1 1,1 $.88 1,1"1.$8 1,8H1.H$ 1,8;$.1$ 1,888.88 10".88 "11."8 08 .;" G18.8G H";.8$ 1,1$8.;H 1,;01.0; 1,10$.8" 1,"$".$" 1,011.11 1, G;.;" 1,$;1.$$ 1,81 .8 1,11$. G 1,;01.0; 18.88: 18.88: 18.88: 11.88: 11.88: 11.88: 11.88: 0.88 ;.08 ".H; "."1 1. ; 1.$G 1.88 1,10$.8" 1,1"8.$" 1,188.H1 1,1"".;1 1,180.8$ 1,8G". ; 1,8"$.G; 1,888.88 10".88 "11."8 08 .;" G10.1; H; .$8 1,18".H0 1,;$H."H 1,10$.8" 1,"$".$" 1,011.11 1, "H.$; 1,$18.11 1,818.;; 1,1;1. H 1,;$H."H 8.88 8.88 8.88 !";. 8 !11. !0. 1 1;.81 "G.$0

Nhat happenedP

Foundations of Finance: Bond Portfolio Management

Moral: 'mmuni+ation is not a set!and!forget strateg). 3ou need to re#alance 4Eread=ustF5 )our portfolio duration *hene,er.

Q Q

interest rates change time elapses

3ou donDt ha,e to turn o,er )our entire portfolio to re#alance. 3ou might simpl) shift a small part of the portfolio from one end of the maturit) spectrum to the other.

7( Immunization 1$en t$e lia.ility is a series of cas$ flo1s: L -arget!date immuni+ation a#o,e assumes that the target lia#ilit) is at a single point 4li.e a +ero coupon #ond5. L For a +ero coupon #ond, ) 9 T.

L 'f the lia#ilit) is a series of cash flo*s, compute the duration of the lia#ilit) portfolio. 'mmuni+ation then re2uires ).ssets ( ) 7iabilities )xam&le 6 Firm 829 is re2uired to ma.e a /0M pa)ment in 1 )ear and a /;M pa)ment in " )ears. -he )ield cur,e is flat at 18: APR *ith semi! annual compounding. Firm 829 *ants to form a portfolio using 1! )ear and ;!)ear 6.S. strips to fund the pa)ments. Mo* much of each strip must the portfolio contain for it to still #e a#le to fund the pa)ments after a shift in the )ield cur,eP
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Foundations of Finance: Bond Portfolio Management

-he value of the lia#ilities is gi,en #): 0MBJ1<8.1B1K 1 < ;MBJ1<8.1B1K 9 ;.0"01M < 1.H$;HM 9 G.0188M.

-he duration of the lia#ilities is gi,en #): 1 CJ;.0"01BG.0188K < " CJ1.H$;HBG.0188K 9 1.GH"$ )ears.

Iet .1 #e the portfolio s dollar in,estment in the 1!)ear strips and .; #e the portfolio s dollar in,estment in the ;!)ear strips. -he dollar ,alue of the portfolio must e2ual the ,alue of the lia#ilities. So .1 < .; 9 G.0188M. -he duration of the portfolio e2uals w1 )1 <41! w 1 5 ); *here w1 9 .1 B G.0188M. -he duration of the 1!)ear strip is 1 and the duration of the ;!)ear strip is ;. Setting the duration of the portfolio e2ual to the duration of the lia#ilities gi,es: 1.GH"$ 9 w1 )1 <41! w 1 5 ); 9 w1 1 <41! w 1 5 ; -hus, .1 9 8 .G"0; CG.0188M 9 0.0"81M .; 9 G.0188M ! 0.0"81M 9 1.H$H$M.
1$

w1 9 8.G"0;.

Foundations of Finance: Bond Portfolio Management

B( #et Wort$ Immunization 6nli.e e.g. pension funds, firms and #an.s care a#out their net *orth as opposed to future commitments. Suppose that a firm has a #alance sheet: .ssets 7iabilities 188 4 ).ssets 9185 8 4 ;8 Set North

)7iabilities 9185

-he firmDs shareholders are not immuni+ed: 'f y goes from 18: to 18.0:, a mar.!to!mar.et #alance sheet *ill sho* 4approximatel)5: .ssets 7iabilities H0 0G "$ SN -o immuni+e the net worth , need . :).ssets (7 :)7iabilities . -o achie,e this, the duration of the assets should #e set to 4 8B1885 C 18 9 )ears.

1H

Foundations of Finance: Bond Portfolio Management

C( Cas$ 0lo1 Matc$in! *Dedication 3trate!y, Cash flo* matching is the strateg) of funding e,er) component of a lia#ilit) *ith a +ero!coupon #ond. -he #ond is said to #e dedicated to a particular o#ligation. Iimitation: a,aila#ilit) of +eros.

D( Limitations of Immunization L Ne ha,e assumed that the )ield cur,e is flat 4the same ) for all maturities5. 'f the cur,e is not flat, a simple modification of ) *ill ser,e as the #asis for immuni+ation as long as shifts in the yield urve are parallel 4all y Ds go up or do*n #) the same amount5. L Should )ou immuni+eP 'mmuni+ation is appropriate *hen the target lia#ilit) is a fixed nominal 4/5 amount. But man) common moti,es for sa,ing 4e.g., retirement or a childDs education5 in,ol,e lia#ilities that are not for fixed / amounts. 'n these cases, *e need an in,estment that has inflation hedging properties.

18