April 10, 2011 4 Comments
Normally,for fixed income instruments , the interest rates corresponding to longer terms are higher than those for shorter terms.However,locking in money for longer periods is not always an option.One way of ensuring a greater degree of liquidity while taking advantage of the higher rates offered for the longer tenures is laddering.
If you want to create a 5 year ladder you could buy a 1year, 2year, 3year,4year and 5year instrument .Then after the first year,renew the matured 1 year instrument for a term of 5 years.Then the following year do the same with the matured 2year instrument.Continue the process.
Laddering ensures that at least some of the higher interest rates are locked in and that the average rate is higher than the rates at the lowest point in the interest rate cycle.
If you are drawing an income from your fixed income instruments say to pay or part pay you a pension,your EMIs,a tution fee or get some passive income,laddering smoothes out the variations.
Laddering is possible with bonds,NCDs,FDs,CDs etc.