CAN YOU PLEASE EXPLAIN WHY REINVESTMENT RISK EXISTS? - ProProfs Discuss
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Can you please explain why reinvestment risk exists?



Asked by Bramwell, Last updated: Nov 26, 2021

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John Smith

John Smith

John Smith
John Smith

Answered Sep 08, 2016

The yield to maturity calculation for a bond is based on the following assumption: each coupon payment you receive is also reinvested at the same rate of return as the original coupon rate. when you buy a bond with a coupon rate of 8% at a time when the market interest rate is also 8%, the price of the bond is 100 and the yield on the bond is 8%. this 8% yield is based on the idea that each and every interest payment you receive can also purchase an investment that has a yield of 8%.but the problem is what happens after you buy the bond and the market interest rate falls, for example, to 3%? each coupon payment you receive can only be invested in fixed rate vehicles that, at best, provide a yield of around 3% - vastly lower than the assumption made by the original yield calculation. reinvestment risk refers to the investor not being able to get the same yield on their coupon payments as their original investment.
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