How can repricing risk be effectively reduced?

How can repricing risk be effectively reduced?

• A. By issuing bonds with a fixed interest rate
• B. By issuing bonds with a floating interest rate
• C. By increasing the duration of the bond
• D. By investing solely in equities

Answer: (B)

Repricing risk refers to the potential for interest rates to fluctuate, affecting the income generated from investments, particularly fixed-income securities. To effectively reduce repricing risk, issuing bonds with a fixed interest rate is a common and effective method. When bonds have a fixed interest rate, their coupon payments remain constant regardless of fluctuations in the market interest rates. This stability ensures that the issuer will not face higher costs in interest payments if market rates rise. Conversely, bonds with a floating interest rate can lead to increased repricing risk since their rates adjust periodically based on market conditions. Therefore, while floating rates might present an opportunity for lower initial costs, they expose the issuer to the unpredictability of future interest rate changes. By issuing bonds with a fixed interest rate, an issuer can lock in a specific cost of borrowing and mitigate the effects of interest rate fluctuations on their overall financial strategy. This not only provides certainty in cash flows but also helps in financial planning and budgeting.

Repricing risk refers to the potential for interest rates to fluctuate, affecting the income generated from investments, particularly fixed-income securities. To effectively reduce repricing risk, issuing bonds with a fixed interest rate is a common and effective method. When bonds have a fixed interest rate, their coupon payments remain constant regardless of fluctuations in the market interest rates. This stability ensures that the issuer will not face higher costs in interest payments if market rates rise.

Conversely, bonds with a floating interest rate can lead to increased repricing risk since their rates adjust periodically based on market conditions. Therefore, while floating rates might present an opportunity for lower initial costs, they expose the issuer to the unpredictability of future interest rate changes.

By issuing bonds with a fixed interest rate, an issuer can lock in a specific cost of borrowing and mitigate the effects of interest rate fluctuations on their overall financial strategy. This not only provides certainty in cash flows but also helps in financial planning and budgeting.