What is the primary concern for an investor heavily weighted in mortgage-backed securities?

What is the primary concern for an investor heavily weighted in mortgage-backed securities?

• A. Credit risk
• B. Political risk
• C. Legislative risk
• D. Prepayment risk

Answer: (D)

The primary concern for an investor heavily weighted in mortgage-backed securities is prepayment risk. Mortgage-backed securities (MBS) are often influenced by the behaviors of borrowers. When interest rates fall, homeowners are more likely to refinance their mortgages to take advantage of lower rates, leading to increased prepayments. This results in the original investors receiving their principal back sooner than expected, potentially at a time when they may have difficulty reinvesting that money at a similar or higher yield due to lower prevailing interest rates. Prepayment risk directly affects the cash flow and yield of mortgage-backed securities, making it a critical consideration for investors who rely on consistent income from these investments. Understanding this risk enables investors to manage their portfolios effectively and anticipate changes in cash flow that can occur due to shifts in interest rates.

The primary concern for an investor heavily weighted in mortgage-backed securities is prepayment risk. Mortgage-backed securities (MBS) are often influenced by the behaviors of borrowers. When interest rates fall, homeowners are more likely to refinance their mortgages to take advantage of lower rates, leading to increased prepayments. This results in the original investors receiving their principal back sooner than expected, potentially at a time when they may have difficulty reinvesting that money at a similar or higher yield due to lower prevailing interest rates.

Prepayment risk directly affects the cash flow and yield of mortgage-backed securities, making it a critical consideration for investors who rely on consistent income from these investments. Understanding this risk enables investors to manage their portfolios effectively and anticipate changes in cash flow that can occur due to shifts in interest rates.