General Securities Representative (Series 7) Practice Exam

What type of bonds have the least reinvestment risk since all earnings are received at maturity?

1. Fixed-rate bonds

2. Zero-coupon bonds

3. Callable bonds

4. Convertible bonds

The correct answer is: Zero-coupon bonds

Zero-coupon bonds have the least reinvestment risk because they do not make periodic interest payments. Instead, they are sold at a discount to their face value and the investor receives the full face value at maturity. Since there are no intermediate cash flows, there is no need to reinvest interest payments, which eliminates the risk associated with fluctuating interest rates that can affect reinvestment returns. This characteristic makes zero-coupon bonds particularly appealing for investors looking to avoid reinvestment risk. In contrast, fixed-rate bonds provide periodic interest payments that need to be reinvested, exposing the investor to the risk of declining interest rates at the time of reinvestment. Callable bonds can be redeemed by the issuer before maturity, which can lead to reinvestment risk if the bonds are called in a declining interest rate environment, forcing investors to reinvest at lower rates. Convertible bonds also involve the potential to convert to equity, but they similarly provide periodic interest payments, creating reinvestment risk. Thus, zero-coupon bonds clearly stand out as having no reinvestment risk, as all earnings are received solely at maturity.