Definition,process,features,limitations and examples of bond immunisation

1. BOND IMMUNIZATION
PRESENTED BY
P.L.SATYAVANI
MBA,M.PHILL

2. A Bond is a debt instrument issued by
governments, corporations and other
entities in order to finance projects or
activities.
In essence, a bond is a loan
that investors make to the bonds issuer.

3. Immunization is a set of rules that is being
used for the purpose of minimizing the
impact of a change in interest rate of a
financial wealth.
3

4. Bond immunization is an investment
strategy used to minimize the interest rate
of bond investments by adjusting the
portfolio duration to match the investors
investment time horizon.

5. Immunization is a technique that makes
the bond portfolio holder to be relatively
stream of cash flows.
The bond interest rate risk from the
changes in the market interest rate.
The market rate effect the coupon rate and
the price of the bond . Immunization locks
in a fixed rate of return during the amount
of time an investor plans to keep the bond
without cashing it in.

6. In general, the longer the term to maturity,
the greater the sensitivity to interest rate
changes.
Example: Suppose the zero coupon yield
curve is flat at 12%. Bond A pays $1762.34
in five years. Bond B pays $3105.85 in ten
years, and both are currently priced at
$1000.

7. • Bond A: P = $1000 = $1762.34/(1.12)5
• Bond B: P = $1000 = $3105.84/(1.12)10
Now suppose the interest rate increases by
1%.
• Bond A: P = $1762.34/(1.13)5 = $956.53
• Bond B: P = $3105.84/(1.13)10 = $914.94
 The longer maturity bond has the greater drop in
price because the payment is discounted a
greater number of times.

8. A portfolio is Immunized when its duration
equals the investors time horizon.
Maintaining an Immunized portfolio means
rebalancing the portfolios average duration
every time interest rates change, so that
the average duration continuous to equal
the investors time horizon.

9. • Default and call risk ignored
• Multiple nonparallel shifts in a nonhorizontal
yield curve
• Costly rebalancing ignored
• Choosing from a wide range of candidate bond
portfolios is not very easy
9

10.  Here coupon rate risk and the price risk can be
made to offset each other.
 Whenever there is an increase in the market
interest rate ,the prices of the bonds fall. At the
same time the newly issued bonds offer higher
interest rate.
 The coupon can be re-invested issued bonds offer
higher int rate & losses that occur due to the fall in
the price of bond can be offset &the portfolio is
said to be immunized.

11. Example : If an investor has invested
equal amount of money in 3 bonds namely
A,B&C with duration of 2,3,4 years
respectively , than the bond portfolio
duration is
D=1/3*2+1/3*4+1/3*3
= 0.66*1*1.33
= 2.77 or 3 years

12. Every time market interest rates change
the duration of every bond changes.
During tends to diminish more slowly than
calendar time for coupon-paying bonds
when interest rates do not change.