Answer:
a. A 20 year, 10% coupon bond
Explanation:
Reinvestment risk refers to the risk of earning lower rate of return than the return earned on current investments.
For example, a $1000, 6% callable bond is issued. The lender earns 6% i.e $60 per annum. Suppose the market interest rates drop to 4% and the issuer redeems these bonds. Then, the lender has to invest his proceeds at 4% and not unlike 6% in previous case.
This means, his rate of return has reduced on reinvestment. This is reinvestment risk.
Bond term is directly related to reinvestment risk. Higher the term, higher the reinvestment risk.
In the given case, 20 year 10% coupon bond bears the most reinvestment risk since the term is more. Higher the term of the bond, higher the possibility that interest rates would be lower than the interest rate at the time of purchase.
The bond above that has the most reinvestment risk is a. A 20-year, 10% coupon bond.
Reinvestment risk is the risk that a bond will be paid off before it matures by the owner of the bond.
Bonds that have long maturities and high coupon rates are especially vulnerable to this risk because the owner could pay it off to tak advantage of lower interest rates.
In conclusion, option A is correct.
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