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Call Options, Points, and Dominance Restrictions on Debt Contracts
Author(s) -
Dunn Kenneth B.,
Spatt Chester S.
Publication year - 1999
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/0022-1082.00190
Subject(s) - callable bond , prepayment of loan , floating interest rate , payment , debt , arbitrage , fixed interest rate loan , loan , economics , monetary economics , interest rate , amortizing loan , call option , business , financial economics , finance , non conforming loan , non performing loan
We analyze the impact of a contract's length, callability, amortization, and original discount by arbitrage methods. Among instruments that are callable without penalty, longer instruments command a higher interest rate because the borrower possesses the option of repaying relatively more slowly. However, the rate on longer self‐amortizing loans cannot be substantially larger than for shorter ones because the payments decrease with contract length. Bounds on the trade‐off between points and rate for callable debt are characterized using the trade‐off for noncallable debt and the property that the value of the prepayment option increases with the loan's interest rate.