Immunization of fixed income portfolios

A portfolio is immunized when it is unaffected by interest rate change. Duration gives a good measure of interest rate sensitivity; therefore, it is generally used to immunize portfolios. As using duration assumes a flat yield curve and a little parallel shift of the yield curve, the immunized portfolio is constrained by these assumptions, and being unaffected will mean that the value of the portfolio changes only slightly as yields change.

There are two different kinds of immunization strategies: net worth immunization and target date immunization.

Net worth immunization

Fixed income portfolio managers often have a view on the way the yield curve will change in the future. Let us assume that a portfolio manager expects rates to increase in the near future. As this would have an unfavorable effect on the portfolio, the portfolio manager could decide to set the duration of the portfolio to zero by entering into forward agreements or interest rate swaps...