If interest rates increase, an investor who owns a mortgage pass-through security is most likely affected by:
A) credit risk.
B) extension risk.
C) contraction risk.

Question

Quizplus · Accepted Answer

When interest rates increase, prepayments on mortgages tend to slow down, leading to extension risk for investors in mortgage pass-through securities. This risk arises because the expected cash flows are extended over a longer period, potentially resulting in lower returns.

If Interest Rates Increase, an Investor Who Owns a Mortgage