text: As interest rates fall people will refinance at the new lower rates. Investors in mortgage backed securities with have their principal returned to them early. This is known as "reinvestment risk", as investors will have to find a new place for the money and the interst rates will be lower. CMO's try to midigate this risk by establishing trantches (www.investopedia.com/terms/t/tranches.asp).\n\nAs interest rates rise pre-payments will decline reducing reinvestment risk. However, the investor will still be exposed to interest rate risk. Meaning that new issues of mortgage backed securities will offer higher returns. The rates of default will increase for marginal borrowers with adjustable rates. In most cases this won't affect the investor, as the bank will foreclose and liquidate the asset. In both cases you will have credit risk, but this in minor, as they are backed by the assets (properties).\n\n* Use this information at your own risk. Consult your financial advisor.