Call Risk vs. Prepayment Risk

[bchad]

In my mind, prepayments and called bonds are the same thing, other than calls are for bonds and prepayments are for mortgages.
Am I missing something here?

 

[jimmylegs]

Sounds right.

 

[bigwilly]

Very close because the Home Owners have a Call Option on their mortgage in the form of prepayment. So yes I would say you are safe with that assumption…

 

[strikershank]

bascially correct. Callable bond has an embedded call option that the owner of the bond is short, much like an MBS that has an embedded call option representing prepayment risk that hte owner of the MBS is short.

 

[PJStyles]

Hmmm… isn’t the difference that MBS payments include both principal/interest with no bullet payment at maturity? Or does that apply to Callable Bonds as well?

 

[bchad]

Well that’s the difference between MBS and regular bonds, but I recall from L1 that some bonds are amortizing as well.
If a bond is called, it’s essentially a prepayment, just like an MBS.
I was asking because I was reading “There are two types of contingent claims risks: 1) Call risk, and 2) prepayment risk”
I started thinking, oh boy, I would only have been able to come up with one risk on the exam, because to me, a prepayment is essentially the same as call risk. It’s feels like saying that there are two kinds of music - country, and western.

 

[hala_madrid]

if you wrote this post because of the end of chapter question… check errata. they removed “callable” from the wording of the MBS, if I remember correctly