Why lower coupon has high reinvestment risk?
Thx a bunch guys!
That is incorrect. Lower coupon has lower reinvestment rate. Are you sure your not confusing lower coupon with higher interest rate risk?
Maybe lower coupon = more likely that the bond will be called if interest rate changes hence more reinvestment risk???
maybe,
Although I believe, generally, the lower the rate, the more likely you can reinvest your coupon payments at that rate or higher. Where as when your coupon is high (relative to average coupon rates through history) you are more at risk of encounter a period of time where you are receving coupon payments at the same time interest rates are lower.
i
lower coupon bonds have HIGHER interest rate risk because the amount of money you get back is heavily relied on the lumpsum payment at the end of maturity.
lower coupon bonds have LOWER reinvestment risk.
you r right, it should be lower coupon have lower reinvestment rate. But why is that?
reinvestment risk is the risk you will not be able to reinvest earnings throughout the period AT THE SAME YIELD.
So, the lower the rate, the more likely you can reinvest your coupon payments AT THAT SAME YIELD or higher.
where as, if your coupon rate was HIGH, then it would be more likely that, when the time came to reinvest, you would be faced with lower rates. That isn’t NECCESSARILY the case, but the risk is higher in that case than if you started at a time with relatively lower coupon rates.
I think a few people here are blending a few different issues. Don’t worry its a common phenomenon when your head is full of information in the few days before the exam. You’ll get very use to it over the next 3 years.
Lower coupon bonds have lower reinvestment risk.
To achieve a yield to maturity that is the same as the bond coupon itself, you need to be able to reinvest the coupons at the same initial coupon rate of the bond itself. Should interest rates fall during the life of the bond, the final yield to maturity will be less for the lower interest earned for the remainder of the term on the coupons that are paid out.
In light of this, a zero-coupon bond has no reinvestment risk and reinvestment risk reduces as the coupon approaches zero (i.e. is lower).
The point made about a bond being called is only applicable for callable bonds but is an associated issue as 100% of the capital will be returned and then must be reinvested as a lower interest rate (as interest rates have fallen). This is just an extreme case of reinvestment risk.