A life insurance firm wants to minimize its interest rate risk, and it is planning on paying out $250,000 in 5 years. Which one of the following investments best matches its goal?

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Quizplus · Accepted Answer

The best investment option for a life insurance company that wants to minimize its interest rate risk and knows that it is going to pay out $250,000 in 5 years are 5-year zero-coupon bonds. Zero-coupon bonds do not pay interest throughout their life; instead, they are sold at a discount to face value and redeemed at face value when they mature. This makes them attractive to investors with a fixed payout in mind because there is no reinvestment risk. Coupon bonds and high-yield utility stocks both carry more investment risk and interest rate risk, which can result in unpredictable returns. Money market investments are rolled over as needed and are therefore unpredictable, so they would not be the best choice in this scenario.

A Life Insurance Firm Wants to Minimize Its Interest Rate