prepayment risk

Prepayment Risk

The risk that a borrower will repay a loan before its maturity, depriving the lender of future interest payments. Prepayment risk is most important for callable bonds, in which the issuer may repay the principal and cease paying coupons after a certain date, and mortgage-backed securities, in which the mortgage holder may refinance his/her mortgage, which will result in the security holder losing future interest. Some callable bonds and mortgage-backed securities have structures embedded within them to reduce prepayment risk. See also: Collateralized mortgage obligation, Yield-to-worst, Yield-to-maturity.

prepayment risk

The risk to a lender that part or all of the principal of a loan will be paid prior to the scheduled maturity. For a bondholder, prepayment risk refers to the possibility the issuer will redeem a callable bond prior to maturity. Prepayments generally occur when market rates of interest decline following the loan origination. Prepayment generally results in reduced cash flow for a bondholder when proceeds from the redemption are reinvested at a reduced interest rate. Also called call risk.

prepayment risk

See option risk.

References in periodicals archive ?
The OAS mechanism takes into account two types of volatility facing fixed-income investments with embedded options: changing interest rates (which affect all bonds) and prepayment risk.
With coverage of all monthly data published by Ginnie Mae, Fannie Mae, and Freddie Mac since 1995, RS EDGE allows users a single point of entry to rapidly access the drivers of prepayment risk and prepayment trends.
The importance of the prepayment risk models that Compass Analytics will provide to Compass and FIS customers cannot be overemphasized," said Kessel.
In the end, it is the borrower who compensates the lenders and investors for the prepayment risk in the form of higher interest rates.
This paper explores the relationship between the prepayment risk embedded in conventional, fixed-rate residential mortgages and excess returns for bank stocks.
Fannie Mae and Freddie Mae face five major sources of business risk: credit risk, prepayment risk, interest rate risk from mismatched duration of assets and liabilities, liquidity risk, and operational risk.
In fact, the potential downside of an exercise-and-hold strategy for NQOs is greater than ISOs, since the former is subject to a higher tax prepayment risk.
Mortgages can be added as needed, thereby eliminating prepayment risk to the investor.
One problem with securities such as those issued by Government National Mortgage Association (Ginnie Mae) is prepayment risk.
The Financial Accounting Standards Board removed from its technical agenda a project on investments with prepayment risk.
Investments with prepayment risk -- The FASB added this subproject to its agenda in January 1991 at the request of the EITF.
These involve credit risk, concentration risk, operational risk, liquidity risk, and interest rate risk, including prepayment risk.