When you first see immunization as a way of liability matching a portfolio, it seems almost too good to be true that we can set up a portfolio and we're going to be able to meet the liability no matter what happens to interest rates and to some degree. It is too good to be true in some aspects. This is not to say that immunization is a poor strategy, but the portfolio manager must be aware that this is not a Buy and Hold strategy, but rather immunized portfolios must be frequently rebalanced. There's a couple of really good reasons for this firstly. immunization assumes a flat yield curve we're assuming that we can get the same level of reinvestment income on all of our coupons no matter when they're received no matter how long that coupon is being reinvested for. If we assume that we're getting the same level of return on every reinvested coupon. Then we must be assuming that we have a flat yield curve which is definitely not the case all of the time. A second reason why portfolios need to be rebalanced is that an immunized portfolio is only protected against a change in interest rates once before the first coupon is receipt. If interest rates, then move again after the first coupon or any subsequent cash flows are received then we won't be perfectly immunized and protected against changes in interest rates. So we do need to rebalance the portfolio as interest rates change. And the final reason why we need to rebalance the portfolio on a frequent basis. It's because the duration of our assets do not erode in the same way that the duration of the liability roads. The duration of the liability erodes on a linear basis. If we are one year closer to the liability falling due its duration has gone down by one. However, the duration of the bond portfolio will not necessarily fall in a linear basis and as a result, we may need to rebalance the portfolio to ensure that we are still duration matched over time.

Other problems with classical immunization are they only protects against interest rate and reinvestment risk. You might feel that you're going to have your liability covered no matter what but we're still exposed to credit risk. We're still exposed to FX risk with this strategy.

And finally, although we can use many more bonds within a classic immunization approach than we could for cash flow matching. There are still certain bonds that we need to be careful not to include within our portfolio specifically bonds with embedded options such as callable or putable bonds because the cash flows on these bonds are highly sensitive to changes in interest rates.