Final Answer:
Lessen the effects of changes in interest rates.
The correct option is 1.
Step-by-step explanation:
A bond ladder is designed to lessen the effects of changes in interest rates. By diversifying bond maturities, a bond ladder helps mitigate the impact of interest rate fluctuations on a fixed-income portfolio. When interest rates rise, the shorter-term bonds in the ladder can be reinvested at higher rates, offsetting potential losses in the longer-term bonds. Conversely, when rates fall, the longer-term bonds provide a stable income stream, balancing the lower yields on reinvested proceeds from maturing shorter-term bonds.
Bond laddering involves purchasing bonds with staggered maturities, creating a "ladder" with bonds maturing at different intervals. For instance, if you have a 5-year ladder with bonds maturing annually, you can reinvest or access funds every year. This strategy ensures a steady income stream while offering flexibility in adapting to changing interest rate environments. The diversification across maturities acts as a risk management tool, reducing the overall sensitivity of the portfolio to interest rate movements.
In summary, the primary purpose of a bond ladder is risk mitigation against interest rate fluctuations. It combines the benefits of regular income, flexibility, and a reduced sensitivity to interest rate changes, making it a valuable strategy for investors seeking stability and income in the fixed-income portion of their portfolio.
The correct option is 1.