Understanding Cash Flow Matching in Fixed Income Strategies

A fixed income portfolio manager is tasked with creating a portfolio that will meet specific future cash flow obligations stemming from a series of pension payments due over the next decade. The manager is considering adopting a cash flow matching strategy with a mix of corporate bonds and government securities to achieve this objective.

The manager will utilize bonds that mature precisely at the times when payments are required. As part of the strategy, the manager has identified two bond options:

1. A 7-year corporate bond that pays a fixed interest rate of 5% and matures on the same date as the first payment.

2. A 10-year government bond that offers a lower yield of 3% but matures at the same time as the second payment.

The portfolio's objective is to construct a low-risk, cash flow-matched portfolio that ensures the right amount of cash is available when needed.