If a mortgage borrower makes prepayments without penalty to take advantage of falling interest rates, the lender will most likely experience:
A) extension risk.
B) contraction risk.
C) yield maintenance.

Question

Quizplus · Accepted Answer

When a borrower makes prepayments on a mortgage, especially to take advantage of falling interest rates, the lender faces contraction risk. This is because the expected duration of the mortgage decreases, potentially leading to reinvestment at lower interest rates.

If a Mortgage Borrower Makes Prepayments Without Penalty to Take