Canadian Securities Course (CSC) Level 1 Practice Exam

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What is reinvestment risk associated with in bonds?

Lowering the overall bond price
Rising inflation rates
Earning a lower return on coupons compared to the purchase rate
Increased liquidity of the bond

The correct answer is: Earning a lower return on coupons compared to the purchase rate

Reinvestment risk is associated with earning a lower return on coupons compared to the purchase rate. This means that when interest rates decline, the investor who is receiving regular interest or coupon payments on a bond may have to reinvest that money at a lower rate than the original bond's yield. This results in a lower overall return than initially expected. The other options are not directly related to reinvestment risk: A. Lowering the overall bond price is generally not a direct result of reinvestment risk. B. Rising inflation rates can impact the purchasing power of bonds, but it is not specifically related to reinvestment risk. D. Increased liquidity of the bond is not associated with reinvestment risk; liquidity refers to how easily a bond can be bought or sold on the market.