India, March 25 -- Consider a scenario in which a AAA-rated bond with a 3-year tenure is offering a decent interest rate of 8% p.a. Akshay invests a lump sum amount in the bond. Akshay's analysis shows that during these three years, market interest rates will fall, bottom out, and rise again. At the time of redeeming the bond and reinvesting the proceeds, he expects market interest rates to be either at the same level of 8% p.a. or higher.

But at the time of reinvestment, similar AAA-rated bonds were offering a substantially lower interest rate of 7% p.a. Akshay tried to time the market and got it wrong. Like Akshay, many fixed-income investors face the reinvestment risk when interest rates are lower. To overcome this situation, investor...