Question
Asked Nov 28, 2019
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Which bond risk components interact to make immunization successful? Explain how these bond risk components interact to immunize a bond portfolio.
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Expert Answer

Step 1

Bond’s duration is adjusted to match its investment horizon. Bond’s duration is the average life of the bond after accounting for the changing interest rate. It also considers the coupons received, redemption value and time horizon. Since, duration is different from the investment horizon as it is affected by the interest rate changes, it is important to immunize the bond to minimize interest rate risk.

Step 2

Immunization is a technique is which the rate of interest on the bonds are fixed through out its investment period, therefore, not being affected by the changing interest rate. Since, bonds and interest rates are inversely related, a decrease in rates would increase the price and vice versa. But when the bond is immunized, thi...

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