Which characteristic is true of mortgage-backed securities?

Mortgage-backed securities (MBS) are financial instruments that represent claims on the cash flows from pools of mortgage loans, primarily home mortgages. One of the key characteristics of MBS is that the quoted yields on these securities often incorporate expected prepayments. This occurs because homeowners may pay off their mortgages earlier than expected, either through refinancing or selling their homes. As a result, the cash flows from the underlying mortgages can vary, which impacts the total return of the MBS. Investors must take these anticipated prepayments into account when assessing the yield, making this aspect fundamental to understanding MBS valuations and risks.

The nature of the underlying mortgages means that cash flow can be inconsistent, and this variability is directly related to prepayment rates, which can be influenced by factors such as interest rate changes and economic conditions. Thus, understanding the implications of prepayment risk is essential for anyone evaluating the yield and pricing of mortgage-backed securities.