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The higher the risk of a security, the higher its expected return will be. A bond's risk level is reflected in its yield, but understanding the different risks involved when investing in bonds is important. The following graph shows the relationship between interest rates and maturity for three security classes: US Treasury securities (USTS), AA-rated corporate bonds, and BBB-rated corporate bonds. Use the selection dropdown lists to correctly associate each curve with its corresponding security class: YIELD (%) 15 12 9 6 3 0 PPP 5 10 15 20 YEARS TO MATURITY 25 30 A B с Frank Barlowe is retiring soon, so he's concerned about his investments providing him with a steady income every year. He's aware that if interest rates the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to annual income from his investments. What kind of risk is Frank most concerned about protecting against?

The higher the risk of a security, the higher its expected return will be. A bond's risk level is reflected in its yield, but understanding the different risks involved when investing in bonds is important. The following graph shows the relationship between interest rates and maturity for three security classes: US Treasury securities (USTS), AA-rated corporate bonds, and BBB-rated corporate bonds. Use the selection dropdown lists to correctly associate each curve with its corresponding security class: YIELD (%) 15 12 9 6 3 0 PPP 5 10 15 20 YEARS TO MATURITY 25 30 A B с Frank Barlowe is retiring soon, so he's concerned about his investments providing him with a steady income every year. He's aware that if interest rates the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to annual income from his investments. What kind of risk is Frank most concerned about protecting against?

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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The higher the risk of a security, the higher its expected return will be. A bond's risk level is reflected in its yield, but understanding the different risks involved when investing in bonds is important. The following graph shows the relationship between interest rates and maturity for three security classes: US Treasury securities (USTs), AA-rated corporate bonds, and BBB-rated corporate bonds. Use the selection dropdown lists to correctly associate each curve with its corresponding security class: **Graph Explanation:** - The graph plots "Yield (%)" on the vertical axis against "Years to Maturity" on the horizontal axis, spanning from 0 to 30 years. - Three curves labeled A, B, and C represent different security classes. - Curve A trends upwards steeply, showing higher yields for longer maturities. - Curve B shows a moderate upward trend. - Curve C has the lowest upward slope, indicating lower yields across maturities. **Dropdown Selections:** - A: [Dropdown Selection] - B: [Dropdown Selection] - C: [Dropdown Selection] Frank Barlowe is retiring soon, so he’s concerned about his investments providing him with a steady income every year. He’s aware that if interest rates [increase], the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to [decreased] annual income from his investments. What kind of risk is Frank most concerned about protecting against?
Transcribed Image Text:The higher the risk of a security, the higher its expected return will be. A bond's risk level is reflected in its yield, but understanding the different risks involved when investing in bonds is important. The following graph shows the relationship between interest rates and maturity for three security classes: US Treasury securities (USTs), AA-rated corporate bonds, and BBB-rated corporate bonds. Use the selection dropdown lists to correctly associate each curve with its corresponding security class: **Graph Explanation:** - The graph plots "Yield (%)" on the vertical axis against "Years to Maturity" on the horizontal axis, spanning from 0 to 30 years. - Three curves labeled A, B, and C represent different security classes. - Curve A trends upwards steeply, showing higher yields for longer maturities. - Curve B shows a moderate upward trend. - Curve C has the lowest upward slope, indicating lower yields across maturities. **Dropdown Selections:** - A: [Dropdown Selection] - B: [Dropdown Selection] - C: [Dropdown Selection] Frank Barlowe is retiring soon, so he’s concerned about his investments providing him with a steady income every year. He’s aware that if interest rates [increase], the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to [decreased] annual income from his investments. What kind of risk is Frank most concerned about protecting against?
**Text Transcription:** **Scenario:** Frank Barlowe is retiring soon, so he’s concerned about his investments providing him with a steady income every year. He’s aware that if interest rates ________, the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to ________ annual income from his investments. What kind of risk is Frank most concerned about protecting against? - ○ Reinvestment risk - ○ Interest rate risk **Question:** Answer the following question based on your understanding of interest rate risk and reinvestment risk. True or False: Assuming all else is equal, long-term securities are exposed to higher interest rate risk than short-term securities. - ○ True - ○ False **Explanation for Concepts:** - **Reinvestment Risk:** This is the risk that future cash flows (for example, from coupon payments on bonds) will have to be reinvested at a lower potential rate of return. Investors like Frank, particularly those nearing retirement, are often concerned with reinvestment risk because it can reduce their income if interest rates fall. - **Interest Rate Risk:** This is the risk that changes in interest rates will negatively impact the value of an investment. For instance, when interest rates rise, the price of existing bonds typically falls. - **Long-term vs. Short-term Securities:** Long-term securities, such as bonds, tend to be more sensitive to interest rate changes than short-term securities, meaning they usually have higher interest rate risk. This sensitivity is due to the longer time until the bondholder receives the bond's principal and changes in rates have more time to influence the bond's overall return.
Transcribed Image Text:**Text Transcription:** **Scenario:** Frank Barlowe is retiring soon, so he’s concerned about his investments providing him with a steady income every year. He’s aware that if interest rates ________, the potential earnings power of the cash flow from his investments will increase. In particular, he is concerned that a decline in interest rates might lead to ________ annual income from his investments. What kind of risk is Frank most concerned about protecting against? - ○ Reinvestment risk - ○ Interest rate risk **Question:** Answer the following question based on your understanding of interest rate risk and reinvestment risk. True or False: Assuming all else is equal, long-term securities are exposed to higher interest rate risk than short-term securities. - ○ True - ○ False **Explanation for Concepts:** - **Reinvestment Risk:** This is the risk that future cash flows (for example, from coupon payments on bonds) will have to be reinvested at a lower potential rate of return. Investors like Frank, particularly those nearing retirement, are often concerned with reinvestment risk because it can reduce their income if interest rates fall. - **Interest Rate Risk:** This is the risk that changes in interest rates will negatively impact the value of an investment. For instance, when interest rates rise, the price of existing bonds typically falls. - **Long-term vs. Short-term Securities:** Long-term securities, such as bonds, tend to be more sensitive to interest rate changes than short-term securities, meaning they usually have higher interest rate risk. This sensitivity is due to the longer time until the bondholder receives the bond's principal and changes in rates have more time to influence the bond's overall return.
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