Immunization of Bonds | CA Final SFM (New Syllabus) Classes & Video Lectures

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Investment in bonds cannot be considered completely risk free. Such investment can have the following two types of risk:

Interest Rate Risk
Reinvestment Risk

Interest Rate Risk:
Such risk arises when interest rate prevailing in market increases.
This will cause an increase in the expectation for the bond holder.
As a result, the discounting rate i.e. DYR increases and the present value of bond decreases.

Reinvestment Risk:
Such risk arises when interest rate prevailing in market decreases.
As a result, the bond that is currently held will have increase in its value.
However, once the bond is redeemed, the investor gets the redemption price in hand.
The investment of such amount cannot be made at the earlier coupon rate and the reinvestment will be at a lower rate resulting into reduced income for the investor.

Immunization of bond is a process of creating a bond portfolio through which the interest rate risk and reinvestment risk can be either eliminated or minimized.

Note:
Immunization cannot be achieved through single bond and creating a bond portfolio is necessary for immunization.