extension risk

Extension Risk

The risk of a loss to an investor in a mortgage-backed security that comes from a lower prepayment rate. The mortgages underlying a mortgage-backed security may be prepaid, which will return the principal amount to the investor sooner. However, this is unlikely to occur when interest rates are rising because mortgage payers have no incentive to refinance to lock in a lower interest rate. This extends the amount of time that the investor has his/her funds in the mortgage-backed security; this could deprive him/her of investing in another security with a higher interest rate. See also: Opportunity cost, interest rate risk.

extension risk

The possibility that rising interest rates will slow the rate at which loans in a pool will be repaid, thereby slowing the return of principal to investors who have committed funds to the pool. For example, rising interest rates will reduce the rate at which holders of mortgage-backed securities have their principal returned.
References in periodicals archive ?
The possibility of extension risk has also been factored into the 'S2' Fund Market Risk Sensitivity Rating.
So mortgage securities that are purchased today, if rates were to rise, would exhibit extension risk, and what you thought was a four-year security might wind up being a seven-year security.
You manage life extension risk by writing better policies.
These partnerships can leverage some of the available grant programs--such as value added producer grants, and the USDA Specialty Crop Block Grants to the states the Sustainable Agriculture Research and Education and Extension Risk Management Education grants program--to enhance the development of these local food marketing outlets for small farmers.
Developing a functional portfolio that complements your core business entails looking at duration risk, call risk, liquidity risk extension risk just to name a few basic metrics.
At the same time, MARC also sees lingering extension risk with respect to the planned early redemption of KMCOB's 2018 sukuk tranche notwithstanding the new timeline of December 31, 2013 for the completion of the West African asset disposals.
As a result, an accurate prediction of duration, taking both extension risk and contraction risk into account, could be a major factor in credit risk management.
Among the risks that regulators cited during the discussion are: extension risk in which the security might not mature at the time it was expected to mature, and that the security would be more volatile than was incorporated in any of its available ratings.
Extension risk is the risk that interest rates will rise and prepayment speeds will slow, and the investor will be left holding the security longer than expected and miss out on opportunities to earn higher rates in the new interest rate environment.
These instruments can, however, expose banks to extension risk as well as reinvestment risk.
Market participants refer to this as extension risk.
The operational characteristics of the synthetic GIC--interest rate guarantee, assumption of pre-payment and extension risk, reinvestment risk and nonparticipating benefit payment risk--are identical to the traditional GIC/BIC product.