Answer: a) Prepayment option

**Answer: A) Prepayment option** MBS are path-dependent because their cash flows depend on how interest rates evolve over time, not just on the current rate. The embedded **prepayment option** means borrowers can refinance or prepay when it is advantageous, so the realized cash flows depend on the path of rates. - **Housing turnover** affects prepayments, but it is not the strongest indicator of path dependence. - **Negative convexity** is a consequence of prepayment optionality, not the source of path dependence. - **Burnout effect** is a path-dependent feature, but it is a manifestation of the prepayment option rather than the broad fundamental cause.

Author: Manit Arora