What is interest rate risk, re-investment risk and default risk?
(i) Interest Rate risk : Interest rate risk, market risk or price risk are essentially one and the same. Theses are typical of any fixed coupon security with a fixed period-to-maturity. This is on account of an inverse relation between price and interest. As interest rates rise, the price of a security will fall. However, this risk can be completely eliminated incase an investor’s investment horizon identically matches the term of the security. (ii) Re-investment risk : This risk is again akin to all those securities, which generate intermittent cash flows in the form of periodic coupons. The most prevalent tool deployed to measure returns over a period of time is the yield-to-maturity (YTM) method. The YTM calculation assumes that the cash flows generated during the life of a security is re-invested at the rate of the YTM. The risk here is that the rate at which the interim cash flows are re-invested may fall thereby affecting the returns. (iii) Default risk : This kind of risk in the
Related Questions
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- What is interest rate risk, re-investment risk and default risk?
