So basically it is a supposition that the principal and interest that are scheduled will be paid off without any installments. Now to understand why this is done, this is basically done to provide a benchmark which can be used to gauge and monitor more complex assumptions. To understand its usages, supposing firms want to budget their resources so that they are within budget, in that case they can determine what a service or a product for that matter of fact will cost without any financing, this would also help the firm to plan for future expenditures and also useful as tool for revenue growth projections.
One of the important tasks where the prepayment assumption model becomes useful is when we are trying to value a mortgage backed security. In this case, we can use of different models and add our assumptions regarding prepayment payments under different interest rate changes and understand how the security behaves. Thus when we have a structured and established standard, it is very helpful for determining the fair value of a investment.
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