Which of the following are not considered a simplifying assumption indicative of the restrictive nature of the option model approach and the option-adjusted spread?
A)The only reasons for prepayment are due to refinancing mortgages at lower rates; there is no prepayment for turnover reasons.
B)The current discount (zero-coupon) yield curve for T-bonds is flat.
C)The mortgage coupon rate is 10% on an outstanding pool of mortgages with an outstanding principal balance of $1 million.
D)Mortgage loans are fully amortized, and there is no servicing fee.
E)The interest rate movements over time change a maximum of 10% up or down each year and the time path of interest rate does not follow a binomial process.

Question

Quizplus · Accepted Answer

The other options listed are considered simplifying assumptions that restrict the accuracy and applicability of the option model approach and option-adjusted spread. Option E, however, is a statement about interest rate movements that does not necessarily reflect the real-world variability of interest rates, which can change by more than 10% in a year and may follow a non-binomial process. Thus, it is not necessarily considered a simplifying assumption, but rather a limitation of the model's ability to fully capture the complexity of interest rate movements.

Which of the Following Are Not Considered a Simplifying Assumption