Interest-Rate & Reinvestment Risk
Interest-rate risk is the chance that rising rates push existing bond prices down — worst for long maturities and low coupons; reinvestment risk is its mirror: falling rates force coupons and called principal to be reinvested at lower yields.
The exam loves a “which bond has the most interest-rate risk” stem — the answer is always the longest maturity with the lowest coupon, and a long-term zero is the textbook winner because it returns everything at the end (its duration equals its maturity). The tell flips when the question swaps “interest-rate risk” for “reinvestment risk”: now the trap answer is that same zero, but a zero has no coupons to reinvest, so its reinvestment risk is effectively zero. Watch for “rates are expected to fall” prompts — that scenario hands you reinvestment risk and call risk, since issuers redeem high-coupon callables exactly when rates drop.
Don’t confuse this with the price–yield seesaw (the directional cause) or with systematic risk classification: interest-rate risk is systematic and undiversifiable — adding more bonds won’t cure it; laddering, hedging, or shortening duration will. A classic miss is pairing reinvestment risk with rising rates; it’s falling rates that hurt reinvestors. Memory hook: high coupons reinvest more, so they carry more reinvestment risk but less price risk — the two pull in opposite directions.
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