Question

Josh is saving money to buy a home in 9 years. Josh currently has a saving of $300,000 and has identified the following strategies to achieve his goal:

a- Buy coupon bonds that mature in 9 years

b- Buy a Treasury STRIPS that matures in 9 years

c- create a bond portfolio with a duration of 9 years

Given his goal, rank these strategies and explain the reasoning behind your ranking system.

Answer 1

I will be trying to rank this portfolio according to the risk management strategies.

1. Creation of a bond portfolio with the duration of 9 year would mean that the investor is trying to eliminate the unsystematic risk in the portfolio & he is trying to take exposure into various types of bonds in order to diversify himself and it will be the best strategy in order to attain his goal.

2. Buying the treasury strips that Mature in 9 years are reflecting that investor is trying to take exposure into the United States treasury bonds and he is trying to to eliminate the credit risk associated with the bond market and is trying to earn risk free rate of interest in order to achieve his goals so it is also a good strategy because he has high exposure in the risk free bonds

3. Buying of coupon bonds that will mature in nine years is the worst strategy out of all three because coupon bonds are mostly corporate bonds which will be having a high risk and they can default over the period of time and investor has also not diversified his portfolio so he will be exposed to a high rate of Risk.