Final answer:
As interest rates decline, the prepayment risk of a mortgage pass-through security increases since borrowers tend to refinance at lower rates, leading to earlier repayment.
Step-by-step explanation:
For a mortgage pass-through security, the risk that most likely increases as interest rates decline is known as prepayment risk. When interest rates fall, homeowners are more inclined to refinance their mortgages at a lower rate, which means they pay off their existing mortgages earlier than expected.
This prepayment scenario can lead to a return of principal to investors in the mortgage-backed securities sooner than they anticipated, which reduces the amount of interest they earn over time. Consequently, as interest rates drop, the associated prepayment risk intensifies.