Thursday, 21 June 2012

Reinvestment Risk

Definition of 'Reinvestment Risk'

The risk that future coupons from a bond will not be reinvested at the prevailing interest rate when the bond was initially purchased.

  • Reinvestment risk is more likely when interest rates are declining.
  • Reinvestment risk affects the yield-to-maturity of a bond, which is calculated on the premise that all future coupon payments will be reinvested at the interest rate in effect when the bond was first purchased. 
  • Zero coupon bonds are the only fixed-income instruments to have no reinvestment risk, since they have no interim coupon payments.  

Investopedia explains 'Reinvestment Risk'

Two factors that have a bearing on the degree of reinvestment risk are:

  • Maturity of the bond - The longer the maturity of the bond, the higher the likelihood that interest rates will be lower than they were at the time of the bond purchase.
  • Interest rate on the bond - The higher the interest rate, the bigger the coupon payments that have to be reinvested, and consequently the reinvestment risk.

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