Cash Flow Matching Strategy for Liabilities

Easy Liability-driven Strategies Cash Flow Matching

John is the fixed income portfolio manager at a pension fund that has a liability to pay $1 million in cash flows at the end of year 5 and another $1 million at the end of year 10. To meet these obligations, John is considering cash flow matching strategies. Cash flow matching involves structuring the investment in such a way that the cash inflows from the portfolio will exactly align with the cash outflows due to liabilities.

Given this scenario, which of the following investment strategies would John most likely choose to effectively implement cash flow matching for his liabilities?

Invest in a zero-coupon bond maturing in 5 years that pays $1 million.

Invest in a series of short-term bonds that mature in less than 5 years.

Invest in a bond ladder consisting of bonds with varying maturities from 5 to 10 years.

Hint

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