SIE (Securities Industry Essentials) Practice Exam

Reinvestment risk is least present in which investment?

1. Zero coupon Treasury Bond

2. Corporate bonds

3. Variable rate mortgages

4. Dividend-paying stocks

The correct answer is: Zero coupon Treasury Bond

Reinvestment risk involves the potential that an investor will be unable to reinvest cash flows from an investment at a rate comparable to the original investment's return. This risk is primarily associated with fixed-income securities, where periodic interest payments (coupons) can be reinvested. Choosing a zero coupon Treasury bond minimizes this risk because it does not provide periodic interest payments. Instead, it is issued at a discount to its face value and pays the full value at maturity. Since there are no interim cash flows generated from the bond to reinvest, the investor does not face the reinvestment risk that comes with investments that provide regular income. In contrast, the other options involve regular cash flows that could lead to reinvestment risk. Corporate bonds pay periodic interest that must be reinvested, variable rate mortgages can lead to uncertain cash flows due to changing rates, and dividend-paying stocks provide regular dividends that shareholders might want to reinvest. Thus, the characteristic of zero coupon Treasury bonds makes them the investment with the least reinvestment risk.