Cash Flow Matching Strategy

Medium Liability-driven Strategies Cash Flow Matching

ABC Pension Fund is committed to meeting its future liabilities to retired employees, which total $5 million and are due in five years. The fund has decided to implement a cash flow matching strategy to ensure it can meet these cash demands. The fund manager considers three investment options:

1. Option A: Invest in corporate bonds that yield 4% annually and will mature at the end of five years.

2. Option B: Invest in government bonds with a yield of 3% that will return $5 million after six years.

3. Option C: Invest in zero-coupon bonds that will generate a lump sum of $5 million at maturity in exactly five years.

Considering the nature of cash flow matching, which investment option should ABC Pension Fund select to best ensure it meets its cash flow requirements in the specified timeframe?

Invest in corporate bonds yielding 4% annually, maturing in five years.

Invest in government bonds returning $5 million after six years.

Invest in zero-coupon bonds providing a lump sum of $5 million in five years.

Hint

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