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06-06-2024
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A mortgage-backed bond is expected to pay the amortized monthly payment of $1000 for 10 years. The bond issuer has an option to prepay the bond after the 2-year lockup period, i.e., paying back the principle and interests in arrear earlier than the amortization schedule. There is another regular bond issued by the same issuer which is identical in all other aspects but without the prepayment option. Which bond should have a HIGHER value to the bond investors?

a. The mortgage-backed bond whose value is the value of the regular bond plus the value of the prepayment option.
b. The mortgage-backed bond whose value is the value of the regular bond minus the value of the prepayment option.
c. The regular bond whose value is the value of the mortgage-backed bond plus the value of the prepayment option.
d. The regular bond whose value is the value of the mortgage-backed bond minus the value of the prepayment option.

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