Mortgage-backed security

In finance, a mortgage-backed security (MBS) is an asset-backed security whose cash flows are backed by the principal and interest payments of a set of mortgage loans. Payments are typically made monthly over the lifetime of the underlying loans.
Residential mortgagors in the United States have the option to pay more than the required monthly payment (curtailment) or pay off the loan in its entirety (prepayment). Because curtailment and prepayment affect the remaining loan principal, the monthly cash flow of a MBS is not known in advance, and therefore presents an additional risk to MBS investors.
Commercial mortgage-backed securities (CMBS) are secured by commercial and multifamily properties (such as apartment buildings, retail or office properties, hotels, industrial properties and other commercial sites). The properties of these loans vary, with longer-term loans (5 years or longer) often being at fixed interest rates and having restrictions on prepayment, while shorter-term loans (1-3 years) are usually at variable rates and freely prepayable.

Reasons for issuing mortgage-backed securities
There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities. Mortgage-backed securities
transform relatively illiquid, individual financial assets into liquid and tradeable capital market instruments.
allow mortgage originators to replenish their funds, which can then be used for additional origination activities.
can be used by Wall Street banks to monetise the credit spread between the origination of an underlying mortgage (private market transaction) and the yield demanded by bond investors through bond issuance (typically, a public market transaction).
are frequently a more efficient and lower cost source of financing in comparison with other bank and capital markets financing alternatives.
allow issuers to diversify their financing sources, by offering alternatives to more traditional forms of debt and equity financing.
allow issuers to remove assets from their balance sheet, which can help to improve various financial ratios, utilise capital more efficiently and achieve compliance with risk-based capital standards.

Real-world Pricing
Most traders and money managers use Bloomberg and Intex to analyze MBS pools. Intex is also used to analyze more esoteric products. Some institutions have also developed their own proprietary software. TradeWeb is used by the largest bond dealers ("primaries") to transact round lots ($1 Million+).
For "vanilla" or "generic" 30-year pools (FN/FG/GN) with coupons of 4.5% - 7% one can see the prices posted on a TradeWeb screen by the primaries called To Be Announced (TBA). This is due to the actual pools not being shown. These are forward prices for the next 3 delivery months since pools haven't been cut . - only the issuing agency, coupon and dollar amount are revealed. A specific pool whose characteristics are known would usually trade "TBA plus {x} ticks" or a "pay-up" depending on characteristics. These are called "specified pools" since the buyer specifies the pool characteristic he/she is willing to "pay up" for.
Another factor which influences pricing is prepayment speed. When a mortgage refinances or the borrower prepays during the month, the prepayment measurement increases. This is usually measured in units of CPR or PSA.
However, it may be advantageous to the holder for the borrower to prepay: if the pool was bought at a discount. This is due to the fact that when the borrower pays back the mortgage he does so at "par." So if the investor bought a bond at 95 cents on the dollar, as the borrower prepays he gets the full dollar back and his yield increases.
This is unlikely to happen as holders of low-coupon MBS have very little incentive to refinance.
If the buyer acquired a pool at a premium (>102), as is common for higher coupons then they are at risk for prepayment. If the purchase price was 105, the investor loses 5 cents for every dollar that's prepaid, possibly significantly decreasing the yield.
This is likely to happen as holders of higher-coupon MBS have good incentive to refinance.
Loan Balance is yet a third factor in pricing. Common specifications for MBS pools are loan amount ranges that each mortgage in the pool must pass. Typically, high premium (high coupon) MBS backed by mortgages no larger than 85k in original loan balance command the largest pay-ups. Even though the borrower is paying an above market yield, they are dissuaded to refinance a small loan balance due to the high fixed cost involved.

Low Loan Balance: < 85k
Mid Loan Balance: Between 85k - 150k
High Loan Balance: > 150k

The link between interest rates and loan prepayment speed
Mortgage prepayments are most often made because a home is sold or because the homeowner is refinancing to a new mortgage, presumably with a lower rate or shorter term. Prepayment is classified as a risk for the MBS investor despite the fact that they receive the money, because it tends to occur when floating rates drop and the fixed income of the bond would be more valuable (negative convexity). Hence the term: prepayment risk.
To compensate investors for the prepayment risk associated with these bonds, they trade at a spread to government bonds. This is referred to as an Option Adjusted Spread.
There are other drivers of the prepayment function (or prepayment risk), independent of the interest rate, for instance:
Economic growth, which is correlated with increased turnover in the housing market
Home prices inflation
Unemployment
Regulatory risk; if borrowing requirements or tax laws in a country change this can change the market profoundly.
Demographic trends, and a shifting risk aversion profile, which can make fixed rate mortgages relatively more or less attractive.