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The immunization strategy is extensively used to protect the nominal
value of a portfolio against interest rate changes, particularly
suitable to pension funds and insurance companies. Given various
types of the term structure of interest rates, this paper studies
how effective the following strategies on immunizing the interest
rate risk of the bond portfolio: Duration Matching, M-Absolute,
M-Square, and M-Vector.
Taiwan government bond data is used to investigate the immunization
effects of the mentioned strategies. The evidence indicates that
actual portfolio values deviate from target values under different
strategies. This results lead to the appropriate application of the
immunization strategies for the bond portfolio managers.
This paper also shows how to manage bond portfolios, to hedge bond
portfolios, and hence solve the following problems in reality.
Fisst, how does an asset manager construct a bond portfolio and
hedge the expected return for the cash outflow? Second, how does
the portfolio manager apply the operation research to construct the
bond portfolio? Third, how does the portfolio manager explain the
properties of the constructed portfolio with different immunization
strategies? Finally, can the portfolio manager construct the
optimal bond portfolio by simultaneously taking into account the
hedging effectiveness, yield to maturity, and construction cost of
the portfolio?
The evidence indicates that, due to the time-varying characteristics
of the interest rate, it is impossible to perfectly hedge the risk
of the bond price with traditional duration matching. For the sake
of immunization effectiveness, management cost, and convenience, it
is better to execute M-absolute or M-Square strategies than the
duration matching.
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