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Answer: American call option at par (i.e., equal to outstanding principal)
The mortgage prepayment feature gives the borrower the right, but not the obligation, to repay the loan early when it is optimal to do so. This is economically similar to an **American call option** on the outstanding principal because the borrower can “call away” the debt early. Since prepayment is generally made by repaying the outstanding principal balance, it is analogous to a call **at par**.
Author: Manit Arora
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Question 49.1 If a homeowner who borrows to finance the purchase of a home can prepay the loan, the prepayment feature of the mortgage is similar to which of the following:
A
American call option at a discount to outstanding principal
B
American call option at par (i.e., equal to outstanding principal)
C
American put option at par
D
European call option at par
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