The Prudent Investor
100

A public agency has:

  • A five-year investment horizon
  • An investment policy allowing maturities up to five years
  • Sufficient liquidity to meet all projected cash needs
  • A portfolio invested almost entirely in overnight investments

The market expects the Federal Reserve to reduce interest rates significantly over the next 12 months.

What is the greatest long-term investment risk facing this portfolio, and what portfolio strategy would best address it?  

What is reinvestment risk, and the prudent strategy is to gradually extend duration by building a diversified ladder of high-quality securities matched to the agency's cash-flow needs?

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