This seems to always confuse me. On Volume 4 Page 38 all it says for interest rate risk is “a rising interest rate environment will adversely affect the value of a portfolio.” For contingent claims risk it starts talking about loss of high coupons and lower reinvestment rates when rates fall.
So is interest rate risk the price risk you get from changing rates and contingent claims risk just moreso the cash flow risk and reinvestment risk components?
Contingent claim risk is applicable to callable bonds for instance.
You have bought a bond at par and this bond has promised 8% return. The bond is callable at 105% of the value of the bond.
Now, 2 years after the issue of the bond, the interest rate has gone down to 6% and the price of the bond is approaching 105. Because the bond may be called back by the issuer at 105, the price will not go up above 105. Moreover, if the interest remains much lower than 8% then the issuer will call it back and hence you will have to surrender the bond and you will lose the future interest payments at 8%. When the bond is surrendered, you will get the money back and now you will have to reinvest the money at a lower market interest rate. (This is the reinvestment risk).
Does this answer your question?
The callable bond suffers reinvestment risk as interest rates fall. When interest rates fall and the bond is called the falling interest rates means that there is no gains from reinvestment. Hence reinvestment risk
Interest rate risk has to do with the sensitivity of the bond price to changes in interest rates ala duration