Reinvestment risk

CFA Level I
#1

Which of the four semiannual fixed-coupon bonds has the least reinvestment risk? A) 10 years to maturity and a 6.25% coupon. B) 15 years to maturity and a 5.50% coupon. C) 8 years to maturity and a 7.75% coupon. D) 15 years to maturity and a 6.00% coupon.

#2

long maturity, low coupon, low yield == high reinvestment risk. (3 L formula) so based on that… choice comes down to between A 10 year, 6.25% coupon and C: 8 year, 7.75% coupon. 15 year got eliminated. again between 8 year and 10 year bond – 10 year bond has the lower coupon, it is eliminated. leaving C as the answer choice. 8 year + 7.75% coupon

#3

I agree with C as well.

#4

cpk123 Wrote: ------------------------------------------------------- > long maturity, low coupon, low yield == high > reinvestment risk. (3 L formula) > > so based on that… > choice comes down to between A 10 year, 6.25% > coupon > and C: 8 year, 7.75% coupon. > > 15 year got eliminated. > again between 8 year and 10 year bond – 10 year > bond has the lower coupon, it is eliminated. > > leaving C as the answer choice. > > 8 year + 7.75% coupon I am going to vote for c myself (longer maturity for A.) .However, i think a low coupon should have low reinvestment risk. i would say the higher the coupon the higher the reinvestment rate.

#5

Lower coupons definitely DECREASE reinvestment risk, however how can we tell which takes precedence, maturity or coupon? for example, the bond corresponding to choice D has a longer maturity than that of choice C, but a lower coupon. Which has more of an effect on reinvestment risk?

#6

I got C also. Between A and C, the reinvestment risk must be lower for the 7.75% bond with 8 years remaining because the total of the remaining coupon payments is lower.

#7

So would it be rational to say that the below as a rule: A) 10 years to maturity and a 6.25% coupon. ~62.5 (10*6.25) coupon payment B) 15 years to maturity and a 5.50% coupon. ~82.5 C) 8 years to maturity and a 7.75% coupon. ~62 D) 15 years to maturity and a 6.00% coupon. ~90 Since C has the lowest coupon payment, hence answer is C.

#8

I would go with D. High reinvestment risk is a trade-off with low interest risk, as book 5 page 22. Therefore, a security with least reinvestment risk will have the highest interest rate risk, which is measured by duration. Equally, least reinvestment risk = longest duration. Then the answer is D, 15 years to maturity and a 6.00% coupon.

#9

sorry . my answer is B) 15 years to maturity and a 5.50% coupon. I forgot 5.5% is lower than 6%. hehe

#10

i am going w/ b also…

#11

B i think

#12

reema, what is the correct answer?

#13

Question ID#: 4620 Your answer: B was incorrect. The correct answer was C) 8 years to maturity and a 7.75% coupon. A bond with a short maturity and a low coupon will have the lowest reinvestment risk. Here, we can rule out the 15-year maturity bonds because they have the longest maturity. To chose between the remaining two bonds, we assume that the maturity effect dominates and thus select the bond with 8 years to maturity. -------------------------------------------------------------------------------------------------------- here is the doubt "we assume that the maturity effect dominates "… what if we had a 30 year maturity and 1% coupon??

#14

it has a longer maturity – so the first criterion would rule it out. This question I believe is reaching the limit of its “staleness”…