Managing the Maturity of Fixed-Income Investments in Rising Interest-Rate Environments

Schellhorn, Carolin D.; Lushbough, Scott H.
August 2005
Journal of Financial Planning;Aug2005, Vol. 18 Issue 9, p62
Academic Journal
When interest rates are expected to increase, investors must choose between a short-term, fixed-income investment strategy that earns relatively low interest rates but preserves the ability to reinvest at higher rates in the future, and a longer-term strategy that locks in a relatively high cur-rent rate but sacrifices the ability to reinvest when interest rates go even higher. Typically, investors are advised to shorten the duration of fixed-income securities. This paper derives a simple equation that financial planners may use to weigh the trade-off between flexibility and higher rates and estimate the preferred maturity for an investor with a given investment horizon and risk aversion. The authors find that the preferred maturity increases with the length of the investment horizon and with investors' willingness to take risk. The preferred maturity is shorter when the opportunity to reinvest is more valuable. Using two alternative methods for estimating the value of investors' opportunity to reinvest, and U.S. Treasury rates reported in March 2004, the authors report estimates of the preferred maturity for a set of hypothetical investors.


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