Final answer:
The S-curve in a fixed-rate mortgage prepayment model illustrates the relationship between prepayment rates of mortgage-backed securities and changes in interest rates, which is crucial for MBS investors to anticipate risks regarding yield and duration of their investments.
Step-by-step explanation:
In a typical agency fixed-rate mortgage prepayment model, the S-curve illustrates the relationship between the prepayment rates of mortgage-backed securities (MBS) and the changing interest rates over time. Initially, when interest rates decline, prepayment rates are slow to respond but eventually increase as more borrowers refinance, this is the bottom part of the 'S'. As interest rates continue to lower, prepayment speeds increase sharply, representing the middle steep curve. Finally, prepayment rates begin to plateau even if interest rates fall further, forming the top portion of the 'S'. This S-curve is significant to MBS investors because it helps them anticipate the prepayment risks associated with their investments, which directly affect the yield and duration of these securities.