extension risk

Extension Risk

The risk of a security lengthening in duration due to the deceleration of prepayments.

Notes:

Extension risk is mainly the result of rising interest rates and is generally associated with mortgage related securities. As interest rates rise, the likelihood of prepayment decreases. Since loans in a pool underlying a security are being prepaid at a slower rate, investors are unable to capitalize on higher interest rates because their investments are locked in at a lower rate for a longer period of time.

See also: Contraction Risk, Duration, Fannie Mae, Interest Rate, Mortgage Backed Security, Pass Through Security, Prepayment Risk

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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.