Question

What is an immunization in a fixed income portfolio? and Why do you need to re-balance your fixed income portfolio to stay immunized?

Answer 1

In a fixed income portfolio, immunization refers to creating & maintaining the portfolio in such a way that a change in interest rates will not affect the value of a portfolio. This is important because many financial products & funds promise to provide a fixed-income to the investors but market interest rates keep changing. So strategies need to be employed to ensure that the portfolio returns will remain fixed.

Immunization can be achieved by cash flow matching, duration matching, and volatility and convexity matching or it may also be achieved by trading derivatives like bond futures & options to hedge against interest rate changes.

It is necessary to re-balance the fixed income portfolio to stay immunized because of following reasons:

1. If a portfolio is currently immunized & interest levels change, then the current level of immunization may not protect the portfolio from further interest changes so it becomes necessary to restructure the portfolio to again achieve the same level of immunization as earlier.

2. As some of the bonds held in the portfolio mature & new bonds added, again the portfolio immunization needs to be adjusted to account for these changes.