VARIATIONS ON IMMUNIZATION

The most common way to immunize a bond portfolio is called combination matching. In combination matching, the portfolio not only matches its duration to its time horizon, but also its cash flow and liabilities. For the first several years of the portfolio, the cash flow from any maturing principal (plus coupon and reinvestment income) is made to equal the portfolio's liabilities. Cash flow is paid out to fund liability payments, giving the portfolio very little cash to reinvest and thus little reinvestment risk. The low reinvestment risk helps the portfolio to lock in a rate of return regardless of interest rate changes.