Reinvestment risk most commonly affects which type of bond?

Reinvestment risk refers to the possibility that cash flows received from an investment, such as bond interest payments or principal repayments, must be reinvested at lower interest rates than the original investment. This risk is particularly significant for callable bonds.

Callable bonds come with the feature that allows the issuer to redeem them before their maturity date, usually when interest rates decline. When a bond is called, the investor receives the principal back and has to reinvest that money. If prevailing interest rates are lower at the time of redemption, the investor faces the risk of reinvesting at those lower rates, diminishing the overall yield they can achieve compared to if the bond had remained outstanding until maturity.

On the other hand, convertible bonds do not inherently carry reinvestment risk since their value is tied to the possibility of conversion into equity rather than the timing of cash flows. Zero coupon bonds, which do not pay interest until maturity, avoid reinvestment risk as they provide a single cash flow at maturity. Municipal bonds, while they can be callable, are not defined by this risk, as reinvestment factors can vary widely among different types of municipalities and bond structures.

Therefore, callable bonds are most associated with reinvestment risk due to the nature of their callable feature