Write specifically about practices in that industry by which interest rate immunization occurs. PENSION FUNDS. Focus on Immunization Strategies for multiple retirement income benefits.
1. I have to read it like I am talking it is a video presentation I have to do for 30 mins. (PENSION FUNDS Immunization Strategies for multiple retirement income benefits.)
THE INTRODUCTION OF THE PAPER IS:
* today we are going to present how the pension fund industry achieves interest rate immunization. We will cover the overall picture, starting with the overall relationship between interest rate immunization and pension funds, followed by the specific immunization strategies used for pension fund assets and liabilities, and we will cap it all off with immunization strategies when holding multiple retirement income benefits, which is a common occurrence throughout this industry.
But first, let’s quickly establish the two most important concepts going forward. These are concepts covered in class so we won’t spend too long on them. The first is duration, which is essentially a measure of the sensitivity the price of a security has to changes in interest rates. And the second is, of course, interest rate immunization or just immunization for short. It is a risk-mitigation strategy that aims to match the duration of assets and liabilities in order to minimize the impact of interest rates on net worth over time.
Conversely, if the investor expects interest rates to decrease, then their wealth can be increased if the difference between the durations of assets and liabilities is less than zero. Of course, if the investor’s forecast is way off, they would lose wealth following either strategy.
So how does this relate to pension funds? It’s simple, many if not most pension funds tend to be significantly underfunded, meaning that the easiest condition to achieve is when the difference between the duration of assets and liabilities are greater than zero. Which again, is the most desirable state to be in if interest rates rise. A pension fund administrator without any strong risk aversions may wish to take advantage of the rate of return movements if indeed the long-term trend is that they will increase over time. But this is the key, there are three factors that should be kept in mind. The second element is basis mismatch, which is essentially the exposure to other rates such as US Treasury or swap rates, which are different from the corporate bond rates used to measure pension fund liabilities. And lastly, there is the net expected yield of the firm’s overall portfolio of which pension funds are a part. We’re not going to get into the specific strategies for this form of “immunization,” but we did want to mention it as it is a form of risk mitigation that is closely related to pension funds, but ultimately it is not interest rate immunization.