Question

What type of security can minimize both price risk and reinvestment risk for an investor with a fixed investment horizon? Explain.

Answer 1

Price risk and Reinvestment risk are one of the most important factors to be considered in making an investment in fixed maturity period. Price risk , Market Risk or Interest rate risk are same and simply on account of an inverse relation between price and interest. Re-investment risk is chances of not getting same (required) interest in case of investment of intermittent cash flows generated by periodic coupons.

To minimize these risks, an investor can invest to Diversify Maturities bond as Investments strategy.

A bond ladder or bond laddering is an investment strategy based on a very simple concept , which is investing in bonds of different maturity periods .

A fixed –floating interest rate Swap can also be used to minimize such risk.

Investment in very long maturity bonds.