ASSET LIABILITY MATCHING REQUIREMENTS
This one is to big firms and even business organisations that want to do this business of avoiding risk by applying some financial common sence that really plays a very crucial if not fundamental role in minimising any risky investment . first of all , what is asset liability matching and the requirements that are needed to match the assets and liability of a certain firm for instance ,
How crucial is asset liability matching ?
Why must i match my assets and liabilities ?
How do i match the assets and liabilities ?
Ok , i have matched the assets and liabilities using system A and B what should i do next ?
Now i will go ahead to define asset liability matching
“asset liability matching is the structuring of assets and liabilitiies in such a way that the number of liability outflow is equal to the number of asset inflow , simple like that .
this definition should not make you think that this is an easy prosess since asset liability matching is prone to errors and it may lead to huge losses but it is better than not using it
When we talkabout it their is some mathematics involved but i am not going to use any mathematics , ill go ahead to explai what the requirements of asset liability matching are ;
ASSET LIABILITY MATCHING REQUIREMENT:
Also known as dedication or absolute matching. In this approach a company structures an asset portfolio in such a fashion that the cash inflow that will be generated from assets will exactly match with cash outflow from liabilities. The following are required in asset liability matching requirement:
1} TERM STRUCTURE OF INTEREST RATES
Interest rates are due to change every time hence when one is matching assets and liabilities the interest rates of each period should be considered thus required. The long term interest rates are favorable. Spot rates are also used.
2} INFLATION RATE OF A PERIOD OF INVESTMENT:
Another important consideration in asset liability matching is the inflation rate of a period of investment. Inflation affects inflow and outflow of an investment, thus required in financial planning models to depict how the inflow and outflow will be affected and proper measures taken to counteract any deviation from profit maximization.
3} YIELD RATES:
These play an important role in asset liability matching. For instance long term investment yield rates are higher than short term hence financial modeling should take into consideration the yield rates to match the asset and liability.
4 TIMING OF CASHFLOWS:}
Timing of cash flows is a significant factor in the analysis of asset liability management in analyzing financial instruments.
5} INSULATIONS OF PORTFOLIONS FROM INTEREST RATES RISK MOVEMENTS:
Most financial institutions try to insulate their portfolios from interest rate risk movements to match their asset and liability. Financial institutions require some obligations of making future payments hence protection through matching.
6} PERIOD OF INVESTMENT:
Another requirement of asset liability matching is the period of investment. This plays an important role in that a business institution will pay out (liability) at a more favorable time in order to avoid losses.
7} CONVEXITY OF INVESTMENT:
Convexity is usually calculated as deviation from the deviation from the duration of investment. It is an important factor in measuring matching of assets and liability as its very accurate.
8} PRESENT AND ACCUMULATION FUNCTIONS:
An institution may require to match the assets and liability hence the present and accumulation functions are important in matching them because they standard recognized functions.
Other asset and liability matching requirements are as depicted below:
9} The funds that a business receives at a certain time and that flows out are used in asset liability matching requirement.
10} When faced with high fluctuations of interest rates and matching of assets and liability. Full immunization plays a crucial role in this context.
let me hope that the managers and othe professionals or any concerned person finds this useful , i am ready for any additional information understanding that nobody has a monopoly of knowledge , do not hesitate to ask any question if you have . thanks and nice moments