Hi Team, Could anyone please confirm what exactly is reinvestment Risk. It would be really helpful if this could be illustrated with an example. As I understand what is given in core reading but want to understand more about it. Like how reinvestment is a risk for a company?
Hi Mahima A numerical example may help. Consider an insurer with a liability to pay in 2 years of 121. They have assets of 100. So if they invest in a zero coupon bond earning 10% pa for two years then they are perfectly matched. However, if they buy a one-year zero coupon bond then they will have 110 at time one. They will then be exposed to a reinvestment risk that interest rates fall below 10% and so they would be unable to meet the liability. Best wishes Mark
