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Reinvestment risk

The risk that coupons and maturing principal have to be reinvested at lower rates than the yield you originally locked in.

yield-to-maturity quietly assumes every coupon is reinvested at the YTM itself. If rates fall, that assumption fails and your realised return is lower than the quoted yield. The longer the horizon and the bigger the coupon, the more of your return depends on it.

Reinvestment risk is the mirror image of interest-rate-risk: falling rates hurt one and help the other. A zero-coupon-bond eliminates it entirely because there is nothing to reinvest.

Example: you buy a 10-year 6% bond at par, expecting 6%. Rates drop to 2% after year one and stay there. Reinvesting $60 a year at 2% instead of 6% leaves you with roughly 5.1% realised over the decade, not 6%.

Related: yield-to-maturity, zero-coupon-bond, interest-rate-risk, coupon

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