Amortizing securities, such as mortgage securities, have similar performance characteristics. A mortgage borrower has the right to pay off, or “call,” the debt before maturity. The mortgage lender therefore has sold a call option to the borrower. Since mortgage securities pass through cash flow from the underlying mortgage loans to investors, investors in mortgage securities have effectively sold call options to borrowers. The homeowners have the economic incentive to exercise these options and prepay when interest rates have fallen, allowing them to refinance and get new mortgages at lower interest rates. The prepayment option.
