contraction vs. prepayment risk

[keep_running]

What is the difference between the two? I assume they both relate to reinvestment risk, but I cannot find any explicit definition that would differentiate the two types of risk.

 

[S2000magician]

Prepayments cause contraction, but so can call options and put options.

 

[keep_running]

Ok, so prepayment risk is what eventually leads to contraction risk?

 

[S2000magician]

Prepayment options are one route to contraction risk, yes.

 

[keep_running]

So is the main risk in both prepayment and contraction risk is reinvestment risk and also the risk of not recieveing cash flows are scheduled times in the future?

 

[S2000magician]

That’s correct.