Bond Immunization: Beyond the Theory
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Date
2005
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Abstract
Several authors in financial investments have investigated the validity of immunization in theory and in applied work. These authors assume different immunized portfolios, apply a few changes in interest rates, and evaluate the process by examining the results.
In this study, we examine different portfolios and define the scope of bond diversification and the selection process of the bonds in order to have more immunized outcomes. Actually, we find that forming immunized portfolios from composites of only two bonds simplifies the selection process and serves in maximizing the overall return of the investment.
We also rely on different websites to gather information on various bonds currently trading in the market. Furthermore, we form a number of immunized portfolios using different pairs of these bonds.
Because the path of interest rates is unknown, we simulate every possible path that interest rates may have for a five years time horizon by using a program in Microsoft Excel, which also calculates the end results of each portfolio in relation to each path of interest rates. Because the range of the outcomes is quite large, we use different statistical summaries and tests in order to evaluate the overall outcome of the portfolios and eventually to validate the theory of immunization.
We use histograms to plot the outcomes of each portfolio and realize that not all portfolios' outcomes have normal distributions as their corresponding data are scattered away from the mean thus increasing the risk of not being able to meet the obligation.
The analysis shows that although all the selected portfolios have means greater than the desired outcome, these portfolios do not have similar risks nor do they have the same probabilities in scoring satisfactory results and we find a relation between the risk and the realized yield of the portfolios.
We conclude by saying that immunization is workable and our analysis provides enough proof to be able to validate this theory especially that we do not use rebalancing in our study, which is one of the problems of the theory, yet we still have positive results.
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Missakian, H. A. (2005). Bond Immunization: Beyond the Theory (MBA thesis, Haigazian University)