Bond ladder
A set of bonds with maturities spaced at regular intervals, so that one matures each period and the proceeds are reinvested at whatever rates then prevail.
Example
Five rungs of 10,000 maturing in one to five years fell 5.2509% on a two-point rise in yields, against 8.4247% for the same 50,000 in a single five-year bond.
Important
A ladder spreads reinvestment risk across several rate environments rather than removing it, and its shorter average maturity is what reduces the price sensitivity. Both effects are real and both are smaller than the technique is usually credited with.
Related terms
- Reinvestment risk — The risk that coupons, or the proceeds of a maturing bond, must be put back to work at a lower rate than the one they came from - which is what makes a quoted yield to maturity conditional rather than certain.
- Duration — The present-value-weighted average time until a bond's cash flows are received (Macaulay duration), and by extension the measure of how much its price moves when yields change. Modified duration is Macaulay duration divided by one plus the yield.
- Maturity — The date on which a bond repays its par value and the contract ends. Bonds are commonly grouped as short, intermediate or long by how far away that date is.
- Duration matching — Choosing fixed income holdings whose timing corresponds to a known future obligation, so the money arrives when it is needed.
Lessons that explain it
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