Updated on November 20, 2023Table of Contents
Reinvestment risk is the risk associated with reinvesting returns from an investment, which can result in lower returns than the original investment.
Reinvestment risk is an important concept for investors to understand as it can affect overall returns. By understanding the causes and impact of reinvestment risk, investors can develop strategies to mitigate its effects.
What is meant by reinvestment risk?
Reinvestment risk is the risk that proceeds from an investment, such as interest or principal, may have to be reinvested at a lower interest rate than the original investment.
What is an example of reinvestment risk?
An example is when a bond paying 5% matures, and the investor has to reinvest the proceeds in a new bond with a lower interest rate, such as 3%.
What is the difference between interest rate risk and reinvestment risk?
Interest rate risk is the risk of a bond’s market value decreasing as interest rates rise, while reinvestment risk is the risk of reinvesting returns at lower rates, affecting future income.
Which bonds have the highest reinvestment risk?
Callable bonds and bonds with frequent coupon payments generally carry higher reinvestment risk, as they are more likely to be reinvested at lower rates if interest rates fall.
What factors increase reinvestment risk?
Falling interest rates and the frequency of cash flows from investments increase reinvestment risk, as the likelihood of reinvesting at lower rates rises.
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