Final answer:
The most significant risk for lenders/investors in mortgage-backed securities is the potential for default by borrowers. Lenders can deal with this risk by conducting thorough credit assessments of borrowers and diversifying their portfolio. These risks influence investment decisions by making lenders/investors cautious and requiring them to assess and price the risks associated with mortgage-backed securities.
Step-by-step explanation:
The most significant risk for lenders/investors in mortgage-backed securities is the potential for default by borrowers. If borrowers do not repay their mortgages, the lenders/investors may experience a loss of income and capital. Lenders can deal with this risk by conducting thorough credit assessments of borrowers before extending loans and by diversifying their portfolio of mortgage-backed securities. This can reduce the impact of defaults on their overall investment returns.
These risks influence investment decisions by making lenders/investors more cautious and requiring them to assess and price the risk associated with mortgage-backed securities. Higher perceived risks may result in lenders/investors demanding higher interest rates or requiring additional collateral to mitigate the risks.Potential investors typically quantify these risks by considering factors such as the credit quality of the underlying mortgages, historical default rates, and the overall economic conditions. They may also rely on credit rating agencies' assessments, although the accuracy of these ratings has been questioned in the past.