NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Investing in Fixed Income Securities
Mr. Iyer, a retired client, wants to invest in a bond and is worried about reinvestment of coupons. Which instrument removes the reinvestment risk of coupons if held to maturity?
A zero coupon bond removes coupon reinvestment risk. It pays no interim interest, only the face value at maturity, so the investor's yield is locked in if the bond is held to maturity and there are no coupons to reinvest at unknown rates.
- AA zero coupon bondCorrect
- BA bond with a high annual coupon
- CA floating rate bond with semi-annual resets
- DA bond with quarterly coupon payments
Explanation
A zero coupon bond pays no interim coupons, so there is nothing to reinvest; the return is locked in if held to maturity. Coupon-paying bonds, whether annual, quarterly or floating, generate cash flows that must be reinvested at uncertain rates.
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