Finance · Bond Valuation and Risk Management
A portfolio manager for an insurance company with a 20-year liability is using a 10-year, 6% annual coupon bond with a duration of 7.5 years for an immunization strategy. Which of the following is the most accurate description of the dual risks associated with this bond and the role of duration in managing them?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The bond faces only reinvestment risk, and this risk is neutralized when the bond's duration is equal to the investor's investment horizon.
- 2The bond faces both reinvestment risk and price risk; Macauley duration is the point in time where these two opposing risks exactly offset each other.✓
- 3The bond faces reinvestment risk and price risk, but the two risks are independent and cannot be aligned or balanced using duration.
- 4The bond faces only price risk, which is the risk that the bond's price will fall if interest rates rise, and duration is irrelevant in managing this.
Correct answer
The bond faces both reinvestment risk and price risk; Macauley duration is the point in time where these two opposing risks exactly offset each other.
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