Extension risk
Asset-Backed Securities glossary · Asset Specific Nuances
Definition
The risk that bond cash flows extend beyond expected timing due to slower prepayments or defaults.
Extension risk in plain English
When you buy this kind of bond, you expect to get your money back on a rough schedule — but that schedule depends on borrowers paying off their loans. "Extension risk" is the danger that you get paid back slower than expected, so your money stays tied up longer than planned. This usually happens when borrowers stop paying early (fewer "prepayments") — for example, when interest rates rise and nobody refinances their mortgage. It's like lending a friend money expecting it back by summer, then learning it won't come until next year: not a loss, but your cash is stuck when you wanted it free.
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