Unit 14:Qbank

Which of the following statements regarding a bond ladder strategy is correct? A) A bond ladder strategy works best when interest rates are stable. B) A bond ladder strategy involves the purchase of very long-term and very short-term bonds. C) A laddered portfolio of bonds will provide lower yields than a portfolio consisting entirely of short-term bonds. D) A bond ladder strategy is a relatively easy way to immunize a portfolio against interest rate risk. Explanation LO 14.a

A bond ladder strategy is a relatively easy way to immunize (protect) a portfolio against interest rate risk. By holding many positions across the yield curve, the individual is diversified in the event that yields behave differently in one part of the curve than in another. The laddered portfolio will generally provide higher, not lower yields than a portfolio consisting entirely of short-term bonds. Buying bonds with very short maturities and bonds with long maturities is the concept behind the barbell strategy. LO 14.a

A risk associated with investing in most bonds is reinvestment risk. What type of bond can an investor buy that does not expose the investor to reinvestment risk of interest? A) Discount bonds B) Zero-coupon bonds C) Premium bonds D) Par bonds

Zero-coupon bonds do not expose investors to reinvestment risk of interest. The risk is that as periodic income is received from an investment, such as bond interest, the investor cannot find another investment to reinvest into offering the same rate of return for the same level of risk. Because zero-coupon bonds do not pay periodic interest, (the return of the face value at maturity is the income), there is nothing to reinvest. The fact that a bond is selling at par, premium, or discount does not remove the reinvestment risk.