Question
Which of the following lowers the interest rate risk by
neutralizing the inflation risk?Solution
Capital indexed bonds are a type of government security that are designed to help investors protect against inflation risk. These bonds are long-term debt instruments with interest rates that are indexed to inflation, which means that the interest rate adjusts automatically based on changes in the inflation rate. By linking the interest rate to inflation, capital indexed bonds help to neutralize inflation risk for investors. This means that if the inflation rate increases, the interest rate on the bond will also increase, helping to protect the investor's purchasing power.
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