Pension funds have played a critical role in the evolution
of the markets for debt and equity securities and their
derivatives in the U.S. over the last 15 years. The new
securities and markets can largely be explained as responses to
the investment demands of pension funds in an environment of
increased interest rate volatility and tighter regulation.
Defined benefit pension plans offer annuities that have a
guaranteed floor specified by the benefit formula. In order to
minimize the cost to the sponsor of providing this guarantee,
there is a strong incentive to invest an amount equal to the
present value of the accumulated benefit obligation in fixed-
income securities with a matching duration. The pursuit of
duration matching and related immunization strategies by pension
funds has contributed to the emergence and rapid growth of
markets for zero coupon bonds, GIC's, CMO's, options, and
financial futures contracts. Recent changes in accounting rules
(FAS 87) and tax law (OBRA) are likely to reinforce the use of
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