Cash flow matching
Buying bonds whose coupons and principal arrive as each liability falls due. It removes reinvestment risk and most rate risk without rebalancing, but usually costs more than duration matching.
Where you will meet it
Cash flow matching appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Contrast approaches to one liability with approaches to a schedule of liabilities, and the different ways each can be implemented
“For several liabilities: Cash flow matching buys bonds whose coupons and principal cover each payment; it is safe but costly and inflexible.”
- Explain why portfolios hold fixed income and the ways fixed-income mandates can be categorised
“Liability-based mandates aim to fund known obligations, as in immunisation or cash flow matching for a pension or insurer.”
- Explain the approach known as liability-driven investing
“Implementation uses long bonds, cash flow matching, immunisation or overlays with swaps and futures.”
- Explain how cash flow matching is used to fund a set of liabilities
“Cash flow matching buys bonds whose coupon and principal payments line up in timing and amount with a schedule of liabilities.”
See also
Practise it
Practise cash flow matching until it is automatic: questions that explain every wrong option.
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