Answer-first summary for fast verification
Answer: $11,685
The value of the prepayment option is the difference between: - the value of the mortgage cash flows discounted at the **non-option yield** of 5.0%, and - the original loan principal of $100,000. Using the 6.0% mortgage payment stream and discounting at 5.0% gives a value of about **$111,685**. Therefore: \[ \text{Prepayment option value} = 111{,}685 - 100{,}000 = 11{,}685 \] So the correct answer is **$11,685**.
Author: Manit Arora
Ultimate access to all questions.
Question 51.1. Assume a 30-year fully-amortizing mortgage loan with original balance of $100,000 and current coupon rate of 6.0% (i.e., Tuckman’s example). But add an assumption that without the prepayment option the interest rate (monthly compounded YTM) would be 5.0%, if priced for its non-option credit quality. What is the value of the prepayment option?
A
$5,685
B
$10,285
C
$11,685
D
$16,385
No comments yet.