Duration Matching

Study guide: Exam FM-2

Duration matching (also called Redington immunization when combined with convexity conditions) is a strategy to protect a Portfolio against small, parallel shifts in interest rates by matching the Duration of assets to the duration of liabilities:

D_{assets} = D_{liabilities}

PV_{assets} = PV_{liabilities}

• These two conditions ensure that if interest rates change slightly, the change in asset value approximately equals the change in liability value

Matching Duration A liability of 10{,}000 is due in 5 years. At i=6\%, PV = 7472.58 and Macaulay duration = 5 years. What asset portfolio should be constructed?

Answer Purchase bonds with total market value $7{,}472.58 and weighted Macaulay duration of exactly 5 years, ensuring the portfolio's value moves in tandem with the liability under small rate changes.