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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

Which of the bonds has the most reinvestment risk? Explain your answer. (Hint: Refer to Table 7.2.)

  1. a. 7-year bonds with a 5% coupon.
  2. b. 1-year bonds with a 12% coupon.
  3. c. 3-year bonds with a 5% coupon.
  4. d. 15-year zero coupon bonds.
  5. e. 15-year bonds with a 10% coupon.

Summary Introduction

To determine: The bond having most reinvestment risk.

Reinvestment risk:

The reinvestment risk is therisk, which means that the principal and interest of the bond will be reinvested at a lower rate than the original investment. The decreasing interest rate causes lesser income from the portfolio of bonds.

Explanation

b.

The bond, which has a shorter maturity period has the most reinvestment risk. If the bond is having a short-term maturity, there will be fewer years. The old coupon bonds with higher interest rates will be replaced by new coupon bonds with lower interest rates. This bond is a 1-year bond and the coupon rate is 12%. It has the shortest maturity period in all the given bonds. So, the reinvestment risk is highest for this bond.

a.

The bond is a 7-year bond and the coupon rate is 5%. This bond has a longer maturity period, so the reinvestment risk is less in comparison to the other bond...

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