To immunize a portfolio consisting of a single coupon bond against a future liability, an investor should select a bond that:

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BlackTom AI · Accepted Answer

Topic focus: immunizing a portfolio against a future liability. The central idea is to choose a bond whose bond-like properties offset changes in interest rates over the intended horizon.
Option D: 'has a maturity date that extends beyond the liability horizon.' While a longer maturity can help with some cash-flow coverage, immunization primarily relies on duration alignment rather than just the final maturity. Extending maturity alone does not ensure that the price changes due to interest rate movements will offset the liability risk over the horizon.
Option B: 'has a duration that exceeds the liability horizon.' If the bond’s duration is longer than the liability horizon, small parallel shifts in the yield curve can cause asset value to move in a way that does not perfectly offset the liability, reducing hedging effectiveness and potentially creating basis risk over the horizon.
Option C: 'has return matching an index' addresses performance relative to a benchmark rather than the sensitivity to interest-rate moves over the liability horizon. Matching an index does not directly immunize against changes in discount rates or ensure cash-flow timing alignment with the liability.
Option A: 'has a duration that equals the liability horizon.' This choice aligns with the classic immunization principle: setting the asset duration equal to the liability horizon helps offset the impact of interest-rate changes on the asset value so that the funded position remains adequate over the horizon. By matching duration to the horizon, the present value sensitivity of the asset approximates that of the liability, reducing net exposures to interest-rate shifts and providing a more stable funding status.
In summary, the duration-matching approach in Option A best satisfies the immunization objective for a single coupon bond against a future liability, whereas the other options fail to guarantee the desired protection against interest-rate movements over the specified horizon.

BU.232.750.51.FA25 Final Exam Fall 2025- Requires Respondus LockDown Browser

To immunize a portfolio consisting of a single coupon bond against a future liability, an investor should select a bond that:

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Five-star Bank is a regional bank in New South Wales. It has immunized the payment of a future liability by making an investment in a coupon bond. The duration of the bond matches that of the liability. Which of the following statements is TRUE if the immunization is effective?

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