What is duration matching in immunization strategies?

• A. Immunization uses duration to balance price risk but not reinvestment risk.
• B. Immunization uses duration to balance price risk and reinvestment risk, aligning portfolio duration with investment horizon to protect against interest rate movements.
• C. Immunization ignores duration and relies on diversification.
• D. Immunization uses duration only for forecasting inflation.

Answer: (B)

Duration matching in immunization strategies aims to align a portfolio's sensitivity to interest-rate changes with the investor's time horizon. By using duration, the approach balances the two main risks involved when investing in bonds: price risk (the drop in value when rates rise) and reinvestment risk (the chance that cash flows received from the investment can only be reinvested at lower rates). When the portfolio’s duration roughly equals the investment horizon, changes in rates have a offsetting effect: price moves raise or lower the value, while reinvestment opportunities adjust in the opposite direction, leaving the final value at the horizon relatively stable. This is why duration is used in immunization—to protect the planned outcome against small shifts in interest rates. It isn’t about ignoring duration, relying on diversification alone, or forecasting inflation.