Zero-Coupon Bonds for Known Future Liability Matching
A father wants to fund his 8-year-old child's college tuition in exactly 10 years. He has a lump sum today and wants to lock in a guaranteed return without having to worry about reinvesting semiannual coupon checks. Which instrument is IDEAL?
Zero-coupon bonds (such as Treasury STRIPS) carry ZERO reinvestment risk because there are no coupon payments to reinvest. They lock in an exact yield to maturity matching the 10-year liability.
Complete Analysis & Legal Rationale
Coupon-paying bonds suffer from reinvestment rate risk: if market interest rates drop, the semiannual interest must be reinvested at lower yields. Zero-coupon bonds eliminate this uncertainty by compounding at the purchase YTM.
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
Zero-coupon STRIPS eliminate reinvestment risk and mature precisely at target college date.
Coupon bonds introduce reinvestment risk over the 10-year holding period.
Floating-rate debt has variable income and unknown maturity values.
Preferred stock is perpetual equity with no fixed maturity date.