Financial Industry Regulatory Authority (FINRA) Practice Exam 2026 - Free FINRA Practice Questions and Study Guide

Prepayment risk is primarily associated with GNMA (Government National Mortgage Association) securities, which are mortgage-backed securities. These securities are backed by pools of mortgage loans, and investors in GNMA are exposed to the risk that the underlying homeowners may pay off their mortgages earlier than expected. When interest rates decline, borrowers are more likely to refinance their mortgages, leading to earlier-than-anticipated repayment of the principal. This situation can impact the returns for investors since they may receive their principal back sooner and might need to reinvest it at lower prevailing interest rates.

In contrast, corporate bonds, Treasury bonds, and municipal bonds typically do not carry prepayment risk. These types of securities are usually structured to have fixed terms, meaning that the issuer does not have the option to prepay the principal before maturity. For example, corporate and municipal bonds are more concerned with credit risk and interest rate risk, while Treasury bonds are influenced heavily by changes in monetary policy and the economic environment. Hence, while other securities may carry various risks, prepayment risk is uniquely tied to GNMA securities due to their nature as mortgage-backed assets.