Final answer:
Immunizing a bond portfolio can essentially eliminate interest rate risk, but not credit or liquidity risks. To mitigate credit risk, diversification across issuers and bond types is essential.
Step-by-step explanation:
The question relates to the risk mitigation that can be achieved through immunizing a bond portfolio. Immunization is a strategy aimed at balancing cash flows to ensure that certain financial goals are met despite interest rate fluctuations.
When a bond portfolio is properly immunized, interest rate risk—the risk that changing interest rates will negatively affect the portfolio's value—can be essentially eliminated. However, it does not address other types of risks such as credit risk, which is the risk of default by the bond issuer, or liquidity risk, the risk that the bond cannot be sold quickly enough to prevent a loss.
To address credit risk, investors can diversify their bond holdings across various issuers and bond types, such as corporate bonds, municipal bonds, and savings bonds. By doing so, investors ensure that even if a few firms fail to meet their payment obligations, not all will likely go bankrupt, therefore mitigating potential losses.