Asked by Annette Herrera on May 07, 2024
Verified
Which of the following is an example of reinvestment risk when investing in the bond market?
A) The coupon rate on a bond is 10% and interest rates on similar bonds have risen by 2%.
B) The coupon rate on a bond is 10% and interest rates on similar bonds have fallen by 3%
C) The coupon rate on a bond is 10% and interest rates on similar bonds are also 10%.
D) Reinvestment risk is not a factor in bond investing because bonds offer investors a risk free investment.
Interest Rates
The percentage of an amount of money charged for its use per period, commonly expressed as an annual percentage rate.
Reinvestment Risk
The risk that future proceeds from investments may have to be reinvested at a lower potential interest rate.
Coupon Rate
The interest rate that a bond issuer will pay to a bondholder, typically expressed as an annual percentage of the face value of the bond.
- Understand the diverse threats involved in bond investment.
Verified Answer
TB
Tsakaia BerkeleyMay 11, 2024
Final Answer :
B
Explanation :
Reinvestment risk refers to the risk that an investor may not be able to find a similar investment with the same return when their current investment matures. In option B, if interest rates on similar bonds have fallen, the investor may not be able to reinvest the coupon payments or the principal at the same rate, resulting in lower overall returns. Option A does not fit as an example of reinvestment risk because if interest rates have risen, the investor can reinvest at a higher rate. Option C also does not fit as an example because there is no change in interest rates. Option D is incorrect because all investments carry risk, including bonds.
Learning Objectives
- Understand the diverse threats involved in bond investment.