Investment Advisor Problem

Robert Wallace began investing in bonds six months ago through tax-exempt municipal securities. His intent at that point in time was to reduce the tax obliga- tion related to his investment portfolio. However, he began to notice that the price of his bonds changed as interest rates changed, and he even took advantage of this phenomenon by cashing in a couple of his 10-year munis early as interest rates dropped and capital gains were available for the taking.

Because of the bond priceinterest rate sensitivity relationship he observed, Robert decided to get more aggressive in his bond investment strategy. He didnt particularly like U.S. government bonds as they pay a lower coupon rate because they have no credit risk. He decided to go for maximum yield on lower-quality corporate bonds while also waiting for interest rates to go down and bond prices to go up. He bought five such 15-year corporate bonds.

In doing a six-months review of Robert Wallaces portfolio, his investment advisor, Brian Gonzalez, said his interest rate strategy was fine, but he was making a fundamental mistake in his type of bond choice based on the Six Bond-Pricing Rules found in this chapter. He proceeded to lend him a copy of Hirt and Blocks Fundamentals of Investment Management.

1. What mistake was Robert Wallace making?

2. Also, from a tax minimization viewpoint, what mistake was Robert Wallace making in the trading of his municipal bonds?