Talk:Reinvestment risk

Preliminary plan for improvements

Greetings Wikipedians! I volunteer to undertake improvements to this article.

• Lead:

1. says it's "one of the main genres of financial risk" but the article on financial risk never mentions it.
2. Differentiate fixed income investment context from the more general risk described in lead.

• Consequences: incomplete sentence.
• Fixed income points:

1. Reinvestment risk = variability in/uncertainty regarding rate at which future cash flows from an investment can be reinvested because of changes in market rates of interest after the initial investment is made. Fabozzi p. 6. This includes a) risk of having to reinvest principal earlier than expected, e.g. callable bond; b) rate at which future cash flows can be invested even if all are made on time; affects interest on interest.
2. When interest rates rise, reinvestment risk works in the investor's favor because the cash flows received can be reinvested in higher-yielding securities. When rates fall, reinvestment risk works against the investor. Neely.
3. Reinvestment risk and interest rate risk have offsetting effects: higher market rates decrease market value of bond but increase rates earned on reinvested coupons. Immunization is a strategy based on the offsetting effects. Fabozzi p. 6. Neely.
4. Reinvestment risk increases with longer holding period; 5-year Treasury bond vs. 30-year Treasury bond. Fabozzi p. 6. Thau p. 60.
5. Due to reinvestment risk, total return earned is unlikely to equal yield to maturity promised at time of purchase.(Fabozzi p. 44-45). Thau.
6. Reinvestment risk is particularly important for mortgage-backed securities, because payments come as frequently as every month. Fabozzi p. 353.
7. Zero-coupon bonds have no reinvestment risk because they have no coupon payments. Thau p. 108.
8. Bonds purchased at premium are more susceptible to reinvestment risk than discount bonds. Homer/Liebowitz p. 140-141. Why: because premium bond is purchased above par but redeemed at par, which is a drag on total return. Therefore, premium bonds' coupon payments and their reinvestment comprise the entire earned return.

• Add inline citations:

1. Fabozzi, Frank J. Bond Markets, Analysis and Strategies.
2. Homer and Liebowitz. Inside the Yield Book.
3. Thau. The Bond Book.
4. The CFA Institute. Understanding Fixed-Income Risk and Return.
5. Neely, Michelle Clark. |Investment Improvement: Adding Duration to the Toolbox. April 01, 1996. The St. Louis Fed.

Any other suggestions? Cordially, BuzzWeiser196 (talk) 15:49, 26 December 2021 (UTC)

Seeing no suggestions after waiting a decent interval (a month), I've published my re-write. I've added a number of inline citations to reliable sources, so I took the liberty of deleting the "Unreferenced (this article cites no sources)" header...which was dated December 2009! Hey, that's 12 years ago. I welcome any comments. Cordially, BuzzWeiser196 (talk) 21:03, 26 January 2022 (UTC)

While this is not an area in which I have a lot of expertise, it does seem like there should be some coverage of mortgage-backed securities, the prepayment risk on which is a notable form of reinvestment risk. Thus MBS are at risk if interest rates go up, due to interest rate risk, or if rates go down, due to prepayment risk. John M Baker (talk) 23:44, 27 January 2022 (UTC)

@User:John M Baker: Thanks for the comment. Your reasoning seems sound. If you have reliable sources that link MBS prepayment to reinvestment risk, by all means go forward. My one reservation is that I'm not sure if MBS prepayment risk belongs in this category, or some other category, of financial risk. I have a textbook that has a chapter on MBS and will take a look at that to see if it supports the point. Cordially, BuzzWeiser196 (talk) 11:14, 28 January 2022 (UTC)

BuzzWeiser196, the sources do seem to discuss prepayment risk and reinvestment risk as two different things, but I don’t see the substantive difference between prepayment risk and the early redemption risk discussed in the article. In any case, they are similar enough that I think there should at least be some kind of reference to prepayment risk. John M Baker (talk) 00:21, 29 January 2022 (UTC)

@User:John M Baker: I'm convinced you have a valid point. Take a look at this discussion from a CFA forum: Reinvestment vs. prepayment risk. Now, to incorporate it into our Wikipedia article, we could create a new section about mortgage lending, that begins with something like this: "Mortgage lenders face the risk that a borrower may repay a portion of the loan earlier than expected. When that occurs, the lender is exposed to reinvestment risk, since it may not be able to make a new loan at the same interest rate." Could you help me to understand: how does that prepayment flow through to the holder of a mortgage-backed security? Perhaps it changes the cash flows received by the MBS holder and thereby creates reinvestment risk? BuzzWeiser196 (talk) 13:47, 29 January 2022 (UTC)

@User:John M Baker: never mind, I found a reliable source (Fabozzi). Added a few sentences and an inline citation. I think this resolves your issue. Cordially, BuzzWeiser196 (talk) 13:59, 1 February 2022 (UTC)

Yes, that seems like a good, solid source. John M Baker (talk) 16:03, 1 February 2022 (UTC)