CMA Final · Strategic Financial Management · Securitization
A housing finance company securitises a pool of ₹80 crore. The pool's expected life is shortened because borrowers repay loans earlier than scheduled, so investors receive principal sooner than expected and must reinvest at lower rates. Which risk does this describe?
This is prepayment risk. When borrowers repay loans earlier than scheduled, investors in the securitised pool get principal back sooner than expected and typically reinvest at lower rates, which reduces their expected return.
- APrepayment riskCorrect
- BCredit risk of the SPV
- CBasis risk
- DLegal true-sale risk
Explanation
Early repayment of the underlying loans shortens the pool's life and returns principal to investors earlier than scheduled, often when rates have fallen, forcing reinvestment at lower yields. This is prepayment risk, typical in mortgage-backed securities.
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