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ntruwant
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Posts: 121
Joined: August 3rd, 2004, 9:50 am

credits: early prepayment option

May 16th, 2006, 12:09 pm

For some credit types, the client has the right to pay to remaining amount back in one time, before the expiration of the credit.Does anyone have an idea how to model such an option (literature, own experience, ...)?
 
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gardener3
Posts: 1496
Joined: April 5th, 2004, 3:25 pm

credits: early prepayment option

May 16th, 2006, 5:55 pm

depends on the credit. for retail loans usually maturity and rates are used as determinants. You can then runs sims to determine the value.
 
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ntruwant
Topic Author
Posts: 121
Joined: August 3rd, 2004, 9:50 am

credits: early prepayment option

May 17th, 2006, 10:03 am

THanks gardener!Do you know which techniques, besides simulations, are used: Black-Scholes-Merton, trees, ...?Which kind of simulations do you mean?
 
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ntruwant
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Posts: 121
Joined: August 3rd, 2004, 9:50 am

credits: early prepayment option

May 19th, 2006, 11:23 am

Come on guys, doesn't anybode have an idea about the theoretical framework for such options???
 
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Swing
Posts: 30
Joined: March 12th, 2012, 9:08 am

credits: early prepayment option

May 9th, 2012, 3:20 pm

Up!Does anyone know how prepayment options are priced ?Many Thanks.
 
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bcreilly
Posts: 7
Joined: August 8th, 2005, 3:28 pm

credits: early prepayment option

May 9th, 2012, 7:04 pm

Not sure if this is helpful, but here are my thoughts in the context of corporate loans with prepayment options.The option shouldn't have any value from an interest rate perspective. With fixed rate loans, any prepayment provision usually is accompanied by an obligation of the borrower to pay a "make whole" amount that would compensate the lender based on the movement of interest rates. For floating rate loans, the prepayment option is usually limited to interest rate reset dates, when the option would naturally have no value.From a credit perspective, the option has value to the borrower if they think they can borrow at a cheaper rate than they are currently paying under the loan. I think you could value this (approximately) as a bermuda option of the borrower to sell CDS protection on itself with the strike price being the CDS level at the time of origination of the loan. How you value a bermuda CDS option is another story...
 
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hamster
Posts: 216
Joined: October 12th, 2008, 3:51 pm

credits: early prepayment option

May 13th, 2012, 3:33 pm

www.algorithmics.com/EN/media/pdfs/arq3-3_credit.pdf the paper follows the "legal claim approach"you can simply value your loan with/without prepayment option from lender's perspective. the difference have to be the prepayment option. things you need to modify:- the paper includes only one-period models- eq 4 is for bullet redemption and fixed coupon (page 27)- the prepayment prob. needs to be calibrated (page 32) - the transaction costs assumptions needs to reflect contemporary market conditions
Last edited by hamster on May 12th, 2012, 10:00 pm, edited 1 time in total.
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