When do we bear contingent claim risk ?
With MBS when IR fall.
With any fixed income security that has an embedded call option given to the issuer. When rates decline, there is a tendency to excecise the call . Not only is the principal returned early ( affecting future cash flows planned ) , but the principal must be re-invested in a declining interest rate environment so the total return drops .
This is the piece to do with contingent claim risk. The FI chapter also descibes interest rate risk and cap risk as the other two.
The above talks of contingent claim risk from the Portfolio Manager who is managing assets.
You also have contingent claim risk from the point of view of managing your liability stream. Say your liability stream contained callable (MBS) bonds in it. When rates fall - they are called - and you have to meet the payments immediately. You may not be in a position too … could go bankrupt trying … and your creditors start to make “contingent” claims on you.