Reinvestment risk
The risk that coupons, or the proceeds of a maturing bond, must be put back to work at a lower rate than the one they came from - which is what makes a quoted yield to maturity conditional rather than certain.
Example
A 5-year 4% bond bought at par returns 4.0000% only if each coupon is reinvested at 4%. Left as idle cash it returns 3.7137%; reinvested at 6% it returns 4.1505%.
Important
It is the mirror image of interest-rate risk, not a second copy of it. Falling rates are good for the price of what you hold and bad for every coupon still to come, and you cannot avoid both.
Related terms
- Yield to maturity — The single discount rate at which the present value of a bond's remaining cash flows equals its current price. It has no closed-form solution for a multi-period bond and is found numerically.
- Reinvestment — Using an investment's income or gains to buy more of the same investment, rather than taking them as cash.
- Zero-coupon bond — A bond that pays no interim interest. It is sold below par and redeemed at par, and the whole of the return is the pull towards par over its life.
- Interest-rate risk — The risk that prevailing yields move and reprice a bond you already hold, because its fixed coupon must now compete with newly issued bonds paying a different rate.
Lessons that explain it
All 578 terms in the Investing glossary