Definition of bond ladder
When an investor decides to hold bonds, there are a variety of strategies with respect to the maturity dates of the bonds for constructing a bond portfolio. Some are simple and others highly complex. The simplest is a bullet portfolio, in which all of the bonds mature at the same time. Another simple strategy is a barbell, in which a significant portion of the portfolio is put into a shorter-term maturity, a significant portion into a longer-term maturity. Yet another of the simple strategies is a bond ladder. In this case, the maturities are spread evenly across a fixed horizon. For example, if an investor selects a 10-year horizon, a pure bond ladder would be to have 10 per cent of the portfolio mature in one year, 10 per cenr in two years, and so on up until the final 10 per cent matures in ten years.
A bond ladder may be set up for several reasons. One is that the investor wants to create annuity income. In the above example, the investor has the cash from the maturing bonds available each year for ten years. Another reason is that the investor decides that he or she does not want to guess the direction of interest rates, and is happy just to accept what is known as the current term structure of interest rates. In this case, as bonds mature each year, the investor roles the maturing bonds over into a new set of ten-year bonds. Hence, the portfolio is maintained as a 10-year ladder on an on-going strategy.