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FP Article 15.15 (To sign up for a FREE 16-lesson eCourse on Investment Risk, please click here.)

Investment Risk - Prepayment Risk

by Rajen Devadason

Ownership often proves more profitable than loanership for two reasons: Equities have a higher risk premium than bonds, and they don't run the risk of being prepaid out of existence just when things start to get interesting!

Rajen Devadason

  Prepayment risk is a type of investment risk that can take on many different shapes and sizes. Let me explain.

For instance, banks are open to prepayment risk when homeowners take advantage of lower costing mortgages to repay their existing home loans. Even retail investors aren't spared exposure to some form of prepayment risk.

Let's say you invested in the loan stock of a company that permits flexible redemption terms.








We'll imagine for the sake of this exercise that you bought 1,000 loan stock of a company known as Loophole Seeker for $1 apiece. It has, let's imagine, a coupon rate of 8%.

Initially, you are very happy with your seemingly safe, secure investment. 

This is an article explaining prepayment risk. I hope you enjoy reading it. But if it isn't what you're looking for, you're welcome to search for something that better meets your needs. Thank you for allowing me to serve you.

Rajen Devadason

Web www.FreeCoolArticles.com










But let's then suppose that six months down the road, interest rates start to fall.

Initially, you would appear to have reason to celebrate because the attractiveness of your loan stock has risen; this should cause its price to rise.

But what if the company's board of directors then decides that since interest rates are falling, it would be wiser for the company to borrow cheaper money from banks and redeem your loan stock early, at $1.

In such a situation, you would have suffered a realised prepayment risk.

If you'd like to continue to learn more about other types of investment risk, here's additional information for you...

15 Types of Investment Risk (OR, to sign up for a FREE 16-lesson eCourse on Investment Risk, please click here.)

1. Borrowing Risk

2. Company Risk

3. Credit Risk

4. Currency Risk

5. Diversification Risk

6. Industry Risk

7. Inflation Risk

8. Interest Rate Risk

9. Liquidity Risk

10. Lost Opportunity Risk

11. Manager's Risk

12. Market Risk

13. Market Timing Risk

14. Political Risk

15. Prepayment Risk



© Rajen Devadason

Web www.FreeCoolArticles.com






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