Which of the following is NOT an advantage of investing in foreign bonds?

• A. Potentially higher returns
• B. Diversification
• C. Hedging against a drop in value of the US dollar
• D. Generally higher liquidity

Answer: (D)

The key idea is comparing the typical benefits of foreign bonds. Foreign bonds can offer potentially higher returns through higher yields and the chance of capital gains in markets outside the U.S., and they add diversification by exposing a portfolio to different economies and interest-rate cycles. They can also help hedge against a decline in the U.S. dollar if the foreign currency strengthens or if foreign interest rates are attractive, providing a currency-related benefit.

However, liquidity in foreign bond markets is usually not higher than in the domestic bond market. These markets tend to be smaller, have fewer participants, and involve more complexities such as currency risk and cross-border settlement, which can widen bid-ask spreads and make large transactions harder to execute without moving prices. Because of these factors, “generally higher liquidity” is not an advantage of investing in foreign bonds, making that option the one that does not fit.