Definition
Reinvestment risk is the uncertainty about the rate at which intermediate cash flows can be reinvested. It is highest for high-coupon, long-maturity bonds because more cash flow is received earlier and must be reinvested. Zero-coupon bonds eliminate reinvestment risk entirely since there are no interim cash flows.
lightbulb Example
An investor buys a 10-year bond with 6% coupon when rates are 6%. Rates drop to 3%. Each semi-annual coupon can only be reinvested at 3%, reducing the realized return below the initial 6% YTM.
verified_user Key Points
- Higher coupon = more reinvestment risk
- Zero-coupon bonds have zero reinvestment risk
- Opposite of price risk—one offsets the other
- Bond ladders mitigate reinvestment risk through diversification