Investopedia

Continue to Site »

Contraction Risk

Filed Under » ,
Dictionary Says

Definition of 'Contraction Risk'

The risk faced by the holder of a fixed income security when borrowers increase the rate at which they pay back the maturity value of the fixed income security. Contraction risk is a component of prepayment risk that increases as interest rates decline. This is because a decline in rates may create an incentive for the borrower to prepay all or part of the outstanding debt, which results in the life of the debt instrument being reduced. As interest rates decrease, the likelihood of prepayment increases.

Investopedia Says

Investopedia explains 'Contraction Risk'

A financial institution that offers a mortgage at an interest rate of 5% expects to earn interest on that investment for the life of the mortgage. However, if the interest rate declines to 3%, the borrower may refinance the loan, or accelerate payments, in order to reduce the number of years that they will have to pay interest to the investor. If the borrower refinances at a lower interest rate, the total payment period is reduced, thus introducing contraction risk.

Articles Of Interest

  1.

    Advanced Bond Concepts

    Learn the complex concepts and calculations for trading bonds including bond pricing, yield, term structure of interest rates and duration.

  2. 6 Tips For Selling Your Home Fast

    Find out what you can do to stand out from the competition and make your home an easy sell.

  3. Why Your Pension Plan Has Sovereign Debt In It

    One type of security pensions tend to invest in is sovereign debt, or debt issued by a government.

  4. 5 Smart Ways To Use Your Tax Return

    This year, find out how to stretch your tax refund further to strengthen your future.

  5. 6 Popular ETF Types For Your Portfolio

    Exchange traded funds are an extremely popular diversification tool that can protect your portfolio during troubled periods.

  6. Top 5 Budgeting Questions Answered

    You don't need a degree to understand your money, begin saving and pay down debt.

  7. Common Liabilities That Hurt Your Net Worth

    Every penny that you keep out of the liability side of the net worth equation essentially ends up on the asset side.

  8. The Dangers Of A Reverse Mortgage

    In many circumstances, a reverse mortgage can be a risk to your financial security. Here are six dangers you should consider before signing on the bottom line.

  9. Automatic Cancellation Of PMI When You're Underwater On Your Mortgage

    You might be suprised to learn that after reaching certain criteria, your PMI will be automatically cancelled.

  10. What Homeowners Need To Know About Zombie Titles

    Understanding how the foreclosure process normally works - and how it dysfunctions in today’s market - will help you avoid becoming a victim.
comments powered by Disqus
Marketplace
Hot Definitions

  1. Disaster Loss

    A special type of tax-deductible loss, similar to a casualty loss, where a loss has been incurred by taxpayers who reside in an area that has been designated as a federal disaster area by the President.

  2. Fool In The Shower

    The notion that changes or policies designed to alter the course of the economy should be done slowly, rather than all at once.

  3. Pattern Day Trader

    An SEC designation for traders who trade the same security four or more times per day (buys and sells) over a five-day period, and for whom same-day trades make up at least 6% of their activity for that period.

  4. Cost-Push Inflation

    A phenomenon in which the general price levels rise (inflation) due to increases in the cost of wages and raw materials.

  5. Happiness Economics

    The formal academic study of the relationship between individual satisfaction and economic issues, such as employment and wealth.

  6. Affluenza

    A social condition arising from the desire to be more wealthy, successful or to "keep up with the Joneses." Affluenza is symptomatic of a culture that holds up financial success as one of the highest achievements.
Trading Center