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Answer: PV(Mortgage cash flows) = Initial Loan Principal Amount plus (+) Value of prepayment option
The fair condition is: PV(mortgage cash flows) = Initial Loan Principal Amount + Value of the prepayment option. Equivalently, Initial Principal Amount = PV(cash flows) - Value of prepayment option.
Author: Manit Arora
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Question 50.2. The Current Coupon Rate satisfies which “fair condition?”
A
PV(Mortgage cash flows) = Initial Loan Principal Amount
B
PV(Mortgage cash flows) = Initial Loan Principal Amount * Value of prepayment option
C
PV(Mortgage cash flows) = Initial Loan Principal Amount plus (+) Value of prepayment option
D
PV(Mortgage cash flows) = Initial Loan Principal Amount minus (–) Value of prepayment option
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