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The most common way to immunize a bond portfolio is
called combination matching. In combination matching,
the portfolio not only matches its duration to its time horizon,
but also its cash flow and liabilities. For the first several
years of the portfolio, the cash flow from any maturing principal
(plus coupon and reinvestment income) is made to equal the
portfolio's liabilities. Cash flow is paid out to fund
liability payments, giving the portfolio very little cash to
reinvest and thus little reinvestment risk. The low
reinvestment risk helps the portfolio to lock in a rate of return
regardless of interest rate changes.
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