An investment maturity strategy which calls for a bank to have all of its investment assets in very short-term maturities is called the __. A. barbell strategy. C. back-end loaded policy. E. None of the options is correct. B. rate expectations approach. D. ladder approach.
The correct answer and explanation is:
Correct Answer: B. Rate Expectations Approach
Explanation (Approx. 300 words):
The Rate Expectations Approach is an investment maturity strategy based on the investor’s or bank’s forecast of future interest rates. In this strategy, banks or investors make investment decisions about the maturity structure of their assets based on expectations of how interest rates will change in the near future.
When a bank expects interest rates to rise, it may adopt a strategy of investing in very short-term maturities. This is because shorter-term securities mature quickly and allow the investor to reinvest at higher interest rates as they become available. This keeps the bank’s portfolio flexible and responsive to rate changes, maximizing returns in a rising-rate environment.
In contrast, if interest rates are expected to fall, the bank may lock into longer-term investments to preserve higher yields before they decrease. Thus, the rate expectations approach is a tactical strategy, where asset maturity is adjusted dynamically to take advantage of forecasted changes in market interest rates.
Why the Other Options Are Incorrect:
- A. Barbell Strategy: This involves investing in both short-term and long-term maturities, skipping the intermediate terms. It is used to balance liquidity and yield.
- C. Back-End Loaded Policy: This term usually refers to timing in budgeting or spending, not a known investment strategy in maturity management.
- D. Ladder Approach: This spreads investments evenly across multiple maturities to reduce reinvestment risk and provide consistent cash flow, not focusing solely on short-term maturities.
- E. None of the options is correct: This is incorrect because Option B is the correct answer.
In summary, when a bank holds all of its investment assets in very short-term maturities in anticipation of changing interest rates, it is using the Rate Expectations Approach.