北大光华金融工程案例课程讲义下.pdf

Prepayment and Prepayment Rate While a mortgage is a long-term debt, the mortgagor can retire the debt before maturity. This early retirement of a mortgage debt is called prepayment. Mortgages are prepayable at par without any penalties. (It has been jokingly said that only the American mortgagors have the inalienable rights to prepay mortgages at par.) Because mortgages amortize, the outstanding principal balance of a mortgage pass-through diminishes over time even when none of the underlying mortgages is prepaid. Since most mortgagors prepay, the outstanding balance of a mortgage pass-through diminishes much more rapidly than its scheduled amortization. Thus, prepayment is defined as only the paydown of the outstanding balance of a mortgage pass-through that is in excess of its scheduled amortization. The “speed” of the excess paydown is measured by the prepayment rate. The prepayment rate is unique to mortgage pass-throughs and is the most important factor in determining their value relative to other fixed income securities, such as Treasurys and corporate bonds. Asset Securitization: Theory and Practice 4 Dr. Joseph Hu Prepayment and Prepayment Rate In a market where interest rates decline steadily, mortgagors would want to take advantage of the lower interest rates by obtaining new mortgages with lower mortgage rates and paying off their existing mortgages that are carrying higher mortgage rates. This behavior, which causes prepayment, is called “refinancing.” Additionally, in an environment of declining interest rates, housing activity usually turns stronger and homeowners may trade up their housing accommodation by selling their existing homes and purchasing bigger and better homes. This trade-