Prepayment Risk

This question tests whether a candidate understands prepayment risk, also called reinvestment risk, in debt and leveraged finance. When a borrower repays early, the lender gets principal back sooner than expected and must decide how to redeploy that capital in the market, which may offer less attractive lending opportunities. Interviewers ask this because it checks a candidate’s grasp of loan economics, yield sensitivity, and the tradeoff between borrower flexibility and lender protection. It also connects to common credit terms such as call protection, make-whole provisions, and prepayment fees, which are important in structuring debt financing.