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 principal risks of investing in the Fund are: allocation risk, credit risk, derivatives risk, dividend risk, exchange-traded funds risk, floating rate loan risk, high yield securities risk, interest rate risk, market risk, mid-size and small-size company risk, prepayment and extension risk, security selection risk.
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.
Mortgage-backed securities are subject to prepayment risk, when the Fund may have to reinvest this money at lower prevailing interest rates, as well as extension risk.
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.
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.
There are risks associated with fixed income investments, including credit risk, interest rate risk, and prepayment and extension risk.
Bennett also noted that while her organization understands NRSRO ratings do not capture all investment risks, most risks are captured in the NAIC's Risk Based Capital formula, with the C1 component capturing the risk of asset default and the C3 component capturing the extension risk.