NISM Certifications · NISM-Series-V-A: Mutual Fund Distributors · Investment Landscape
Which of the following best describes 'reinvestment risk' faced by an investor in a fixed-income instrument?
Reinvestment risk is the risk that interest payments or maturity proceeds have to be reinvested at a lower rate than the original yield, reducing the overall realised return. It differs from credit risk, inflation risk and liquidity risk, which concern default, purchasing power and saleability respectively.
- AThe risk that the issuer will fail to pay the principal on maturity
- BThe risk that interest or maturity proceeds must be reinvested at a lower rate than the original yieldCorrect
- CThe risk that the price of the security falls because inflation rises
- DThe risk that the security cannot be sold quickly without a price concession
Explanation
Reinvestment risk arises when coupons or maturity proceeds can only be reinvested at lower prevailing rates, reducing the overall realised return. Option one describes credit (default) risk, option three describes inflation-linked price risk, and option four describes liquidity risk.
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