If an investor's portfolio is significantly weighted with mortgage-backed securities, she is MOST concerned with?

When an investor's portfolio is heavily weighted with mortgage-backed securities (MBS), prepayment risk becomes a significant concern. MBS are structured from pools of mortgages, and homeowners have the right to prepay their mortgages, particularly when interest rates decline. This results in cash flows being returned to the investor sooner than expected.

Prepayment risk is problematic for investors because it can lead to lower overall returns than initially anticipated. When borrowers refinance their loans during lower interest rates, the amount of income the investor receives diminishes, and they may need to reinvest those funds at potentially lower prevailing rates. This unpredictability complicates cash flow management and overall risk assessment.

While interest rate risk, credit risk, and inflation risk are all relevant concerns for investors in fixed-income securities, they do not capture the specific dilemmas presented by mortgage-backed securities. Interest rate risk, for instance, affects the value of the security due to changing rates, but it does not directly account for the behavior of homeowners in prepaying their loans. Thus, prepayment risk stands out as the foremost concern for investors heavily invested in MBS.