SIE practice questionmediumReinvestment Risk
Reinvestment risk is the risk that:
- ACash flows from an investment (coupons, principal) must be reinvested at lower interest rates✓ Correct answer
- BA company will not reinvest its profits back into the business
- CAn investor's portfolio will lose value in a market downturn
- DAn investor will be unable to find new investments to purchase
Explanation
Why A — Cash flows from an investment (coupons, principal) must be reinvested at lower interest rates
Reinvestment risk occurs when interest payments or returned principal must be reinvested at lower prevailing rates. This is greatest in a declining interest rate environment and for callable bonds (which are called when rates fall). Zero-coupon bonds have ZERO reinvestment risk because there are no intermediate cash flows to reinvest. High-coupon bonds have more reinvestment risk.
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