Does the length of a bonds maturity affect Reinvestment/Prepayment Risk?
My guess is yes, because there is a longer time for rates to have a chance to fall to a level that would make sense for the issuer to call (prepay) the bond. Reinvestment risk is higher because prepay risk is higher? I dont know what do you guys think
Absolutely. Time to maturity has a large impact on reinvestment risk. Longer maturity = greater reinvestment risk because of TMV impact of reinvested funds.
If you receive payment earlier you are at risk of not being able to invest it at same rate as initially thought. A long term maturity? I think it is more risk, but not yet sure … thinking, and thinking…
Longer maturity definitely increases Duration. They question, is what components of duration (risk) does it affect.
My thought now is that it increases reinvestment risk because more of the total value of the bond is made up by interest payments. I seem to remember reading this.
yea it’s not as clear…i know it definitely affects duration, but as to if it affects prepayment/reinvestment risk? who knows.
MT, > My thought now is that it increases reinvestment risk because more of the total value of the bond is made up by interest payments but if maturity is long, it means you get smaller coupon payments, right? So, why should that increase reinvestmnet risk? You’d have more risk if you received large payments. I’m beginning to think it decreases risk!!!
Coupons are the same throughout the life of the bond. With a longer duration, there is higher reinvestment risk because you would have more coupons to reinvest. Prepayment risk I think exists if the bond is callable (like a mortgage for instance).
ah you’re right coupon payment is the same. Still, this is troubling… With longer maturity, duration is bigger, so for any changes in interest rates, bond price will rise or fall by a larger percentage. So, if you are holding longer maturity you are subject to more price swings than another person holding a shorter maturity bond. That’s fine, and does not say your reinvestment risk is higher…! Now since you continue to receive coupons more than the shorter maturity bond guy, you are exposed to the trouble of reinvesting those coupons more often than the guy who bought the shorter maturity bond. However, that guy is in even more trouble, because he will receive his entire principal sooner, and he would have to reinvest it…thus it looks like he is at more reinvestment risk!!!
Fixed income has three basic factors: coupon rate, par value and maturity. When we consider change one of the factors, does it means that the others are certain? In this question, if maturity is longer, does it means that coupon rate and par value are identical? If that is so, I think it might make sense.
I’m with map1 on this one. More coupon payments = more coupon payments to reinvest = longer time horizon where rates might move on you If you think about a bond with 1 coupon payment then 100% prin is repaid and a bond with 1000 coupon payments and then prin is repaid, under which scenario are you more likely to experience decrease in rates? As far as prepayment (as in callable or early amortization like in MBS), I’d say the same thing. In looking at a AAA tranches with different WALs in the same securitization, the ones with the higher WALs definitely have more prepay (and many other risks too, hence the higher spread) risk embedded in them.
For exam purposes we know what the answer is: longer maturity means more reinvestment risk. To your argument: > If you think about a bond with 1 coupon payment then 100% prin is repaid and a bond with 1000 coupon payments and then prin is repaid, under which scenario are you more likely to experience decrease in rates? Don’t you think the person with 1 coupon + principal has a larger sum to contend with? Thus more re-investment risk? So each year he has a larger sum to deal with…This what needs to be clarified.
No, the person with 1 coupon and the principal around the corner is 1 period away from obtaining his YTM. The closer a bond gets to maturity, the smallest is the risk to not obtain YTM.
alright…that’s a better definition of reinvestment risk. So, re-investment risk is the risk of not getting the contracted YTM. I think I was thinking of something else: two senarios, one investment matures in 10 years, and another investment matures in one year, but repeats for 10 years!!! Which one is subject to more re-investment risk? I’m not sure what that is called.
my inclination was to say yes… but i wanted to verify my logic. page 429 of CFAI Volume 5 “For a given yield to maturity and a given non-zero coupon rate, the longer the maturity, the more the bond’s total dollar return depends on reinvestment income to realize the YTM at the time of purchase-- that is, the GREATER the reinvestment risk”
Dreary Wrote: ------------------------------------------------------- > For exam purposes we know what the answer is: > longer maturity means more reinvestment risk. > > To your argument: > > > If you think about a bond with 1 coupon payment > then 100% prin is repaid and a bond with 1000 > coupon payments and then prin is repaid, under > which scenario are you more likely to experience > decrease in rates? > > Don’t you think the person with 1 coupon + > principal has a larger sum to contend with? Thus > more re-investment risk? So each year he has a > larger sum to deal with…This what needs to be > clarified. what about for a 30yr zero vs a 10 year high coupon bond?. The 10yr definitely has higher reinvestment rate risk.
the zero has zero reinvestment risk
exactly, so long maturity doesnt always mean more investment rate risk?
correct when considering a zero against another security, not always when considering coupon paying