Duration Matching for Liability-Driven Investment Strategy

Hard Liability-driven Strategies Duration Matching

A fixed income portfolio manager is evaluating the liability-driven investment strategy for a pension fund that has projected cash flows of $10 million due in 5 years and $15 million due in 10 years. The manager seeks to construct a bond portfolio that matches the duration of these liabilities to minimize interest rate risk. The current yield curve is upward sloping, with the 5-year and 10-year bond yields at 3% and 4% respectively.

To effectively implement a duration matching strategy, the manager considers three options for bond selection:

Invest exclusively in a 5-year zero-coupon bond.

Invest in a combination of 5-year and 10-year bonds, ensuring the weighted average duration matches the liability's duration.

Invest in a 5-year and a 10-year bond, focusing solely on coupon payments.

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