What commonly affects the yield of mortgage-backed securities?

The yield of mortgage-backed securities is primarily influenced by prepayment rates of the underlying mortgages because these rates directly affect the cash flow that investors receive. When homeowners refinance or pay off their mortgages early, the cash flows to the mortgage-backed securities are altered. Higher prepayment rates lead to a faster return of principal to investors, which can reduce the overall yield since the remaining investment is now at a lower interest rate. Conversely, if prepayment rates are low, investors may receive their expected cash flows for a longer period, potentially maintaining or increasing yield.

Other factors, while relevant, do not directly influence the yield of mortgage-backed securities as significantly as prepayment rates do. Government regulations might impact the structure and function of mortgage-backed securities but do not inherently change their yield. Interest rates impact the attractiveness and pricing of mortgage-backed securities, but again, prepayment behavior is a more direct factor in determining actual returns. Overall market performance can influence investor sentiment and demand for mortgage-backed securities, yet it does not specifically dictate the yield structure like prepayment rates do. Therefore, the primary focus on prepayment rates as a determinant of yield is well-founded and critical for understanding the dynamics of these investments.