The Right to Prepay: A Complex Analysis for Financial Engineers

Topics:
Investment and Capital Markets
Tags:
Analysis,
Debt,
Finance,
Financial,
Financial Accounting,
Financial Engineering News,
Financial Services
Source:
Financial Engineering News

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Overview: This paper highlights a case study on fixed Income. Determining when to prepay on a debt contract at a fixed price is a problem frequently encountered in finance. The net value of each future prepayment right can be estimated in different ways. One method is to employ simulations. However, it is difficult in simulations to determine at what value non-callable debt, prepayment should occur. Often a mere ad hoc rule is utilized, whereby refinancing is assumed to occur when interest rates are a set amount, such as 2%, below the coupon rate of the debt.

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