An example of reinvestment risk is a case in which a financial institution:Group of answer choicesFunds 4-year maturity assets with 6-year maturity liabilitiesFunds 4-year maturity assets with equityFunds 4-year maturity assets with 4-year maturity liabilitiesFunds 6-year maturity assets with 3-year maturity liabilities.
Question
An example of reinvestment risk is a case in which a financial institution:Group of answer choicesFunds 4-year maturity assets with 6-year maturity liabilitiesFunds 4-year maturity assets with equityFunds 4-year maturity assets with 4-year maturity liabilitiesFunds 6-year maturity assets with 3-year maturity liabilities.
Solution
Reinvestment risk is the risk that future cash flows – either coupons (interest payments) or the principal – will have to be reinvested in the future at a lower potential interest rate.
This risk is most relevant when the maturity of the assets is longer than the maturity of the liabilities, because the institution will receive cash from the liabilities before the assets mature. This means the institution will have to reinvest this cash, potentially at a lower interest rate.
So, the correct answer is:
"Funds 6-year maturity assets with 3-year maturity liabilities."
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