Reinvestment risk is one of the main genres of financial risk. The term describes the risk that a particular investment might be canceled or stopped somehow, that one may have to find a new place to invest that money with the risk being there might not be a similarly attractive investment available. This primarily occurs if bonds (which are portions of loans to entities) are paid back earlier then expected.

Consequences

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Reinvestment risk is the reason why many mortgages and other types of loans have prepayment penalties. When the lender or investor lends the money at 5%, the borrower will most likely continue paying off the loan until interests rates go lower, in which case he would refinance the loan to get a lower rate. In refinancing the loan, he pays back the original lender, but now the original lender must find a new place to put their money. Since rates are lower now, it would be impossible then to make the same loan at five percent. To help compensate for this, many lenders implement some sort of prepayment penalty.

Finance