1215

The reinvestment assumption is less important if the coupon and term to maturity are:

Coupon

Term to Maturity

A) lower shorter

B) lower longer

C) higher shorter

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This question is asking: when is the risk of a bond investor having to reinvest bond cash flows (both coupon and principal) at a rate lower than the promised yield?  Reinvestment risk increases with longer maturities and higher coupons, and decreases for shorter maturities and lower coupons. Reinvestment risk is important because the yield-to-maturity (YTM) calculation for a bond assumes that the investor can reinvest cash flows at exactly the coupon rate. (Note: YTM calculations are discussed in a later LOS.)

All else equal, the bond with the shorter term to maturity is less sensitive to changes in interest rates and prepayment rates. Here, this means that a shorter-term bond has lower reinvestment risk than a longer-term bond. 

All else equal, a lower coupon rate means that it is more likely that the investor can reinvest the coupon cash flow at near or equal to the yield-to-maturity. Here, this means that a lower coupon bond has less reinvestment risk.

In summary, reinvestment risk is least important with the combination of shorter maturity and lower coupon rate.