SIE: 5.1.1.2.8. Reinvestment Risk

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5.1.1.2.8.  Reinvestment Risk

Reinvestment risk is the risk that interest earned from a bond cannot be reinvested at an interest rate equal to or higher than the coupon rate of the bond. When interest rates fall, an investor will have to reinvest the interest at the lower rate. Zero coupon bonds have no reinvestment risk because they have no periodic coupon payments. As discussed above, bonds that are callable are particularly exposed to interest rate risk. When interest rates decline, issuers may decide to reduce their interest payments by issuing new bonds at a lower rate and using the funds to call their callable bonds.

SUMMARY: Types of Risk

Risk

Securities Affected Most by this Kind of Risk

Strategies to Protect Against this Type of Risk

Market risk
  • • Stocks
  • • High yield bonds
  • • Buy puts on broad based index
  • • Short broad-based ETFs

Purchasing power risk
  • • U.S. Treasuries
  • • Safe fixed-income securities, such as bonds and preferred stock
  • • Invest in stocks, REITs, and ADRs

Interest rate risk

  • • Bonds, especially those with high durations
  • • Preferred stock
  • • Invest in stocks and convertible bonds

Credit/default risk
  • • Bonds, especially high-yield bonds
  • • Invest in safer bonds and stocks, and Treasuries

Business risk
  • • Stocks and bonds
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