1. Liability Funding Strategies

2. Asset Liability Management Types of Liabilities of Institutional Investors –Amount Known, Time Known (GIC) –Amount Known, Time Uncertain (LIC) –Amount Uncertain, Time Known (Floater) –Amount Uncertain, Time Uncertain (Auto Insurance)

3. Liquidity Concerns Uncertainty about timing and amount of liabilities Possible reduction in cash in-flows (on account of early cancellation of policy)

4. Immunization- Single Liability Lets say, the liability is 12.5% 5.5 years liability to be paid at the end of term. How will you go about creating your portfolio? –Invest in 12.5% 5.5 years coupon bonds. Will it work? No change in yield Decline in yield Rise in yield

5. Immunization- Single Liability Invest in 15 year 12.5% bonds. Will it work? –No change in yield –Rise in yield –Decline in yield

6. Immunization- Single Liability Invest in 0.5 year 12.5% bonds. Will it work? –No change in yield –Rise in yield –Decline in yield

7. Immunization- Single Liability Invest in low maturity –Low Interest Rate risk –High Interest Rate risk Invest in high maturity –High Interest Rate risk –Low Interest Rate risk How do we balance the two?

8. Immunization- Single Liability Consider an 8 year 10.125% bond –Rise in interest on interest offsets decline in price, if yield rise –Decline in interest on interest offsets rise in price, if yield decline Why is it so?

9. Immunization- Single Liability Consider an 8 year 10.125% bond –Rise in interest on interest offsets decline in price, if yield rise –Decline in interest on interest offsets rise in price, if yield decline Why is it so? We matched the duration of our investment with that of liabilities…

10. Immunization- Single Liability So far, we had been assuming one time decline in yield. What if the market yield fluctuates over investment horizon?

11. Immunization- Single Liability So far, we had been assuming one time decline in yield. What if the market yield fluctuates over investment horizon? –Changing duration will warrant continuous rebalancing of the portfolio Tradeoff between transaction cost and missing the target

12. Immunization Risk Risk of immunization is the risk of reinvestment Higher the high dispersion of cash flows around the liability date- higher the risk of reinvestment –Can we reduce the risk to zero!! –Is there a cost to it!!

13. Contingent Immunization To start with –Immunized r.o.r > Safety r.o.r –We have some safety cushion –Continue active strategy

14. Contingent Immunization If value of portfolio < discounted value of liabilities –Manager required to immunize the portfolio

15. Multiple Liabilities Multiperiod Immunization Cash flow matching