Which strategy has the highest re-investment risk and why?
Assuming that the comparable portfolios have equal duration, laddered has the most reinvestment risk. They will have an immediate, regular stream of securities that will mature over time and will need to be reinvested.
Thanks. So it would be laddered followed by barbell?
Barbell has highest reinvestment risk, followed by laddered portfolio and then bullet.
I’m getting conflicting answers here. Wouldn’t reinvestment risk be higher with the ladder because it has more cash flows?
@fino_abama is correct.
In terms of reinvestment risk, we have: Barbell > Ladder > Bullet.
In reading 19, CFAI curriculum says: “Compared with the barbell, the laddered portfolio has much less cash flow reinvestment risk”.
It also says in paragraph before, referring to the ladder: “This “diversification” over time provides the investor a balanced position between the two sources of interest rate risk—cash flow reinvestment and market price volatility. Bonds mature each year and are reinvested at the longer-term end of the ladder, typically at higher rates than short-term securities. Over time, the laddered portfolio likely includes bonds that were purchased at high interest rates as well as low interest rates.”
Given that you are reinvesting more frequently, you are less exposed to interest rates moves by a sort of averaging, while in the barbell you may have short term bonds expiring in extreme rate movements scenario and that has a strong negative effect on portfolio.
Makes perfect sense now. Thanks.
I am wrong, the barbell has a larger portion in the short duration range. A laddered portfolio has more dispersion and more time in between each maturing bond.