Answer: B) Cash flows do not incorporate prepayments

This is the EXCEPT choice because a static cash flow model typically does incorporate prepayments, but only by assuming a fixed prepayment pattern. The model is called static because those prepayment assumptions do not change dynamically with interest rates.

The other choices are genuine weaknesses of static cash flow MBS analysis:

• It is not really a pricing model in a dynamic sense.
• It can generate misleading price-yield and duration-yield curves because cash flows are held fixed.
• It does not capture negative convexity, since it does not let prepayments respond to changing rates.