What is a mortgage-backed security?
Mortgage-backed security, often referred to as a MBS, is a bond secured by a real estate property. Investors generally buy a group of these mortgages from investment banks or government agencies.
Why are they so special?
There are a handful of reasons why. First off, each monthly payment goes through a bank and then reaches an investor. Secondly, MBSs tend to amortise. In other words, you receive a little bit of the principal payment alongside the regular monthly payments. Thirdly, MBSs have a floating maturity date due to the unscheduled prepayments that occur for a variety of reasons, from refinancing to homeowner bankruptcy. This is where risks lie, or to be more precise, the prepayment risks.
How long do they live?
There is a special metric that measures the effective maturity of mortgage-backed securities. It's called a WAL or simply an 'average life' of a MBS. To be able to define WAL, multiply the following: the date of each monthly payment and the percentage of the final payment paid off at this very date. Then we have the sum of the results.
Thus, the life of a MBS directly depends on the final payment bits you receive each month.
What about yields?