An investor purchases a 10-year, $1,000 face value bond with a 6% annual coupon paid semi-annually for $950. Three years later, market interest rates have dropped significantly. If the bond is callable at $1,030, what risk is the investor most exposed to?

Question: An investor purchases a 10-year, $1,000 face value bond with a 6% annual coupon paid semi-annually for $950. Three years later, market interest rates have dropped significantly. If the bond is callable at $1,030, what risk is the investor most exposed to?

Answer options: ✅ Reinvestment risk

• Interest rate risk
• Inflation risk
• Liquidity risk

Correct answer: Reinvestment risk

Explanation: Callable bonds expose investors to reinvestment risk. If interest rates fall, the issuer may call the bond, forcing the investor to reinvest the principal at a lower prevailing interest rate.