 # Reinvestment risk

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.

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 agree with C as well.

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.

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?

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.

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.

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.

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

i am going w/ b also…

B i think

reema, what is the correct answer?

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??

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