Prepayment risk1 min read

Prepayment risk occurs when the bond is paid off by the issuer earlier than the stated maturity. This normally occurs in a mortgage backed security (MBS) or a bond with a call option. If the issuer chooses to pay the bond early (which will happen when the interest rates are lower), the investor will have to reinvest the prepayments in a lower interest rate environment which will reduce the IRR (internal rate of return) of the investor.