ABC Pension Fund has a long-term liability of $50 million that is structured to pay out benefits beginning in 10 years and continuing for the following 15 years. The fund's investment committee is focused on employing a liability-driven investment strategy to ensure the security of its obligations. The committee is particularly interested in understanding how to effectively match the duration of its fixed income investments to the fund's liabilities. Consider the current yield curve as follows: 3-Year Maturity: 2.5% 5-Year Maturity: 3.0% 10-Year Maturity: 3.5% 15-Year Maturity: 4.0% 20-Year Maturity: 4.5% Your task is to develop an investment strategy that matches the duration of the pension fund’s liabilities effectively. Discuss the importance of duration matching in the context of liability-driven investment strategies, calculate the approximate duration of the pension fund's liabilities, and identify suitable fixed-income instruments that can be utilized to achieve this matching. Include considerations of yield to maturity, credit quality, and any other relevant factors that could impact the suitability of the chosen instruments.

Exam

CFA Level 3

Section

Difficulty

Fixed Income Portfolio Management

Liability-Driven Investment Strategy for ABC Pension Fund

Hard Liability-driven Strategies Duration Matching

ABC Pension Fund has a long-term liability of $50 million that is structured to pay out benefits beginning in 10 years and continuing for the following 15 years. The fund's investment committee is focused on employing a liability-driven investment strategy to ensure the security of its obligations. The committee is particularly interested in understanding how to effectively match the duration of its fixed income investments to the fund's liabilities.

Consider the current yield curve as follows:

3-Year Maturity: 2.5%
5-Year Maturity: 3.0%
10-Year Maturity: 3.5%
15-Year Maturity: 4.0%
20-Year Maturity: 4.5%

Your task is to develop an investment strategy that matches the duration of the pension fund’s liabilities effectively. Discuss the importance of duration matching in the context of liability-driven investment strategies, calculate the approximate duration of the pension fund's liabilities, and identify suitable fixed-income instruments that can be utilized to achieve this matching. Include considerations of yield to maturity, credit quality, and any other relevant factors that could impact the suitability of the chosen instruments.

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