Corporate Bonds
If interest rates decline significantly, which of the following is MOST likely to occur with mortgage-backed pass-through securities?
Prepayment risk = rates fall, money comes back fast. Extension risk = rates rise, money comes back slow.
Complete Analysis & Legal Rationale
When interest rates fall, homeowners are more likely to refinance their mortgages at lower rates. This causes prepayments to increase, returning principal to MBS investors sooner than expected. This is prepayment risk - investors must reinvest the returned principal at lower prevailing rates.
Distractor Autopsy (Why Other Options Are Traps)
FINRA exam writers design incorrect distractors using specific calculation mistakes and regulatory misconceptions. Review why each option succeeds or fails:
Does not match the governing securities rule described in the explanation.
Matches the verified teaching point in the explanation.
Does not match the governing securities rule described in the explanation.
Does not match the governing securities rule described in the explanation.
Official Standard: Outline-level citation: item maps to Series 7 topic coverage. Prefer a specific FINRA/SEC/MSRB rule citation in a later author pass.