Immunization Strategy for Multinational Fixed-Income Investments

This paper extends the results of Gadkari and Spindel (Solomon Brothers 1989), Hauser and Levy (JBE v.43, 1991), and Leibowitz, Bader, and Kogelman (JFI v.3, 1993) who show that hedging currency risk converts some or all of the foreign-held claims to synthetic domestic claims. Fixed-income asset and liability portfolios held in various currencies by multinational operating companies and financial institutions are subject to a combination of foreign currency risk and interest rate risk. Redington (JIA v.18, 1952) and Bierwag, Kaufman, and Toevs (JFQA v.18, 1983) show how to immunize interest rate risk in a fixed-income portfolio invested in a single currency. When their approach is extended to the problem of immunization in the multinational arena, interest rate risk and currency risk must be managed simultaneously. Direct implementation of their approach would require separate matching of duration of assets and liabilities in each country, a solution that is likely to be prohibitively costly. In this paper, we explore the conditions under which the multinational firm can dramatically lower hedging costs by matching the overall duration of asset and liability portfolios rather than matching those durations separately in each country. In that setting, the optimal management of interest rate and foreign currency risks can be separated too