Glossary - Reinvestment Risk
Reinvestment risk refers to the possibility that an investor may not be able to reinvest cash flows (e.g., dividends, interest payments) from an investment at a rate equal to the investment's current rate of return. This risk primarily affects fixed-income securities and is a concern in declining interest rate environments, as the proceeds from bonds or other fixed-income investments maturing or being called may have to be reinvested at lower prevailing interest rates, potentially resulting in lower income.
Also known as
- Interest Rate Reinvestment Risk
Use cases examples
- Bond Offering Memorandum: Investors are warned about reinvestment risk, as there is no guarantee that the interest rates will remain the same upon the maturity of the existing bonds.
- Investment Fund Prospectus: The fund might face reinvestment risk if the interest incomes from the fund's assets have to be reinvested at lower rates due to a decline in market interest rates. This could affect the fund's overall yield.
Considerations for investors
- Investors should be aware of the interest rate environment and future rate projections when investing in fixed-income products to gauge potential reinvestment risks.
- Diversify the maturity dates of fixed-income investments to spread and potentially mitigate the impact of reinvestment risk.
Considerations for founders
- Understand that reinvestment risk can affect the returns on capital raised through debt, possibly impacting future interest expenses.
- Consider the timing of cash flows and maturity profiles of investments to mitigate reinvestment risk.
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