Question

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

Answer 1

Considering a fixed investment horizon, a zero coupon treasury bond having a maturity period matching the investment horizon of an investor can minimize both price risk and reinvestment risk.
Reinvestment risk in case of a bond refers to reinvestment of the cash flows from the bond at a return close to current investment rate of return. As a zero coupon treasury bond do not pay any coupon payment, it won't carry any reinvestment risk.

The bond holder in case of a zero coupon treasury bond, receives a guaranteed payment at maturity of the bond. This payment is equal to face value or par value of the bond. Price risk (increase or decrease in a bond value due to interest rates) matters if a bond is sold before maturity.. However, on selling a bond at its maturity, price risk won't matter as the payment will be equal to face or par value.