Prepayment risk is primarily associated with:

Prepayment risk is primarily associated with mortgages and loans that allow borrowers to repay their debt before the scheduled maturity. This risk arises because when interest rates fall, borrowers are more likely to refinance their loans or pay them off early to take advantage of lower rates. Consequently, investors in mortgage-backed securities or other debt instruments that contain prepayment options may face the risk of receiving their principal back sooner than expected, which can disrupt their income stream.

Understanding this risk is crucial for investors in the housing and mortgage markets, as it affects the expected cash flow and yields from these financial instruments. In models of interest rate risk, prepayment risk is a significant factor that can lead to reinvestment risk, as investors may have to reinvest the returned principal in a lower interest rate environment, thus leading to lower overall returns.

This concept typically does not apply to bonds issued by municipal authorities, penny stocks, or equities with fixed dividends as these financial instruments have different characteristics and risks associated with them.