Contraction Risk

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Contraction Risk

The risk that the duration of a debt security will decline because of prepayment. Duration is the length of time it takes to receive the present value of future principal and interest payments on a debt security; prepayment will deprive the holder of a bond of future coupons, resulting in less interest and therefore a shorter duration. Contraction risk is most prominent in mortgage-backed securities. See also: Prepayment risk.
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Further, the company is exposed to margin contraction risks due to fluctuation in raw material prices, though moderated to an extent by the presence of cost escalation clauses in contracts with its customers.