Tuesday, October 28, 2008


Reinvestment Risk.
The cash flows received from a security are usually (or are assumed to be) reinvested.The additional income from such reinvestment, sometimes called interest on interest, depends on the prevailing interest rate levels at the time of reinvestment as well as on there reinvestment strategy.The variability in the returns from reinvestment from a given strategy due to changes in market rates in called reinvestment risk.
The risk here is that the interest rate at which interim cash flows can be reinvestment will fall.Reinvestment risk is greater for longer holding periods .It is also grater for securities with large,early cash flows such as high-coupon bonds.
It should be noted that interest rate risk and reinvestment risk opposite each other.For example interest rate risk is the risk that interest rates will rise,thereby reducing the price of a fixed income security.In contrast,reinvestment risk is the risk that interest rates will fall.A strategy heaved on these two offsetting risks is called "immunization".

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