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Re-investment risk is the risk that future proceeds from an investment, such as interest or principal payments, may be reinvested at a lower rate than the original investment. This risk is particularly relevant for fixed-income securities, such as bonds, where investors receive periodic coupon payments or the principal at maturity. If interest rates fall during the investment period, reinvesting these proceeds at lower rates could reduce the overall return on the investment.
An investor holding a 10-year bond with a 5% coupon faces re-investment risk if interest rates drop to 2%, as they would have to reinvest coupon payments at the lower rate.
• The risk that future proceeds from an investment may be reinvested at lower interest rates.
• Particularly relevant for fixed-income securities like bonds.
• Can reduce overall returns if interest rates decline during the investment period.
It affects the returns investors can earn on periodic interest payments if rates decline, reducing the overall yield of the bond.
Investors can use strategies like bond laddering or investing in zero-coupon bonds to minimize the impact of fluctuating interest rates.
When interest rates rise, re-investment risk decreases, as investors can reinvest proceeds at higher rates, potentially increasing overall returns.
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