Which of the following statements best describes interest rate and reinvestment rate risk?
A) Variable (or floating) rate securities have more interest rate (price) risk than fixed rate securities.
B) Interest rate price risk exists because fixed-rate debt securities lose value when interest rates rise, while reinvestment rate risk is the risk of earning less than expected when interest payments or debt principal are reinvested.
C) Interest rate price risk can be eliminated by holding zero coupon bonds.
D) Reinvestment rate risk can be eliminated by holding variable (or floating) rate bonds.

Question

Quizplus · Accepted Answer

Interest rate price risk refers to the potential loss in value of a fixed-rate security when interest rates rise, while reinvestment rate risk is the risk that the investor will be unable to reinvest the cash flows from the security at the same rate, resulting in lower than expected returns. It is not possible to eliminate either type of risk completely, but strategies such as diversification and managing the duration of the portfolio can help to mitigate them. Zero coupon bonds do not eliminate interest rate price risk, as they are subject to changes in market interest rates. Similarly, variable or floating rate bonds do not eliminate reinvestment rate risk, as the investor remains exposed to changes in interest rates at the time of reinvestment.

Which of the Following Statements Best Describes Interest Rate and Reinvestment