Deck 12: Financial Leverage and Financing Alternatives

Question 1

A loan in which the lender receives part of the proceeds from the sale of the property is known as a convertible loan.

Answer 1

False

Question 2

The loan alternative with the highest ATIRR will always be preferable to the borrower.

Answer 2

False

Question 3

When constructing a convertible mortgage, the lender will require a contract interest rate equal to or greater than the market rate on a similar mortgage without conversion option.

Answer 3

False

Question 4

If a property has positive leverage, the owner should borrow as much as possible.

Question 5

Everything else equal, the loan balance on a negative amortization loan will be less than that on an interest-only loan after the first year.

Question 6

A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $60,000, what is the maximum amount of debt service the lender would allow?

A) $30,000
B) $50,000
C) $60,000
D) $72,000

Question 7

One benefit of leverage is that it reduces the variation in returns or losses.

Question 8

Under which conditions would one be MOST LIKELY to see an interest rate swap?

A) A borrower wants a fixed rate loan, but the bank only offers floating rate loans; the borrower "swaps" loans with someone who has a fixed rate loan
B) A borrower does not have enough equity for a conforming loan, so he or she takes out a "second" mortgage loan
C) A borrower does not have enough equity for a conforming loan, so he or she "swaps" mortgage insurance for increased equity investment
D) A bankruptcy court orders a lender to "swap" a debtors high interest rate for a lower interest rate

Question 9

An interest only loan will provide a higher debt coverage ratio than an amortizing loan with the same interest rate.

Question 10

All other things being equal, which of the following best describes the effects of leverage on an investment's risk-return characteristics assuming the expected return is greater than the lending rate)?

A) Lower expected return, lower risk
B) Lower expected return, higher risk
C) Higher average return, higher risk
D) Higher average return, lower risk
E) Risk-return characteristics have no role in investment decision making

Question 11

In an inflationary environment where property values are also rising, a participation loan may provide a lender with some protection against unanticipated inflation.

Question 12

One advantage of a sale-leaseback is that the lease payments are 100 percent tax deductible.

Question 13

To determine whether leverage is positive or negative, the investor needs to determine whether the IRR is greater than market rate of interest on mortgage loans.

Question 14

One advantage of using leverage is that NOI increases with higher amounts of leverage.

Question 15

Properties with a higher ratio of debt are considered to also have a higher risk assuming everything else is equal.

Question 16

One benefit of leverage is that it allows investors diversify across several investments

Question 17

If a property owner borrows money at a rate that is higher than the equity yield rate, negative leverage exists.

Question 18

When the internal rate of return on an investment increases as the loan-to-value ratio increases, positive leverage exists.

Question 19

Financial leverage is defined as the benefits that may result to an investor by borrowing money at a rate of interest that is lower than the expected rate of return on total funds invested in a property.

Question 20

An investment has the following characteristics: ATIRR_P: After-tax IRR on total investment in the property: 9.0%
BTIRR_E: Before-tax IRR on equity invested: 17%
BTIRR_P: Before-tax IRR on total investment in the property: 12%
T: Marginal tax rate: 0.40
What would be the break-even interest rate BEIR), at which the use of leverage neither favorable nor unfavorable?

A) 15.0%
B) 20.0%
C) 22.5%
D) 28.3%

Question 21

Which of the following is also referred to as a negative amortization loan?

A) Participation loan
B) Accrual loan
C) Convertible loan
D) Interest only loan

Question 22

A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $45,000, what annual amount of debt service would provide the required debt coverage ratio?

A) $37,500 or higher
B) $37,500 or lower
C) $54,000 or higher
D) $54,000 or lower

Question 23

A loan in which the lender receives a percentage of the net operating income from the property is known as an):

A) Participation loan
B) Accrual loan
C) Convertible loan
D) Percentage loan

Question 24

Which of the following gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time?

A) Convertible loan
B) Sale-leaseback
C) Accrual loan
D) Interest only loan

Question 25

Which of the following is NOT a benefit of a sale-leaseback of land for investors?

A) It is a way of effectively obtaining 100% financing
B) The lease payments are tax deductable
C) Land can not be depreciated for tax purposes
D) The land value may increase over the holding period

Question 26

If properly constructed and assuming everything but the structure of the interest payment is equal, which of the following loans would typically have the highest first-year debt service?

A) Accrual loan
B) Conventional loan
C) Interest only loan
D) Participation loan

Question 27

A property is financed with an 85% loan-to-value ratio at 10% interest over 25 years. What would the BTIRRE on equity be estimated at given that the BTIRRP is 10.75%?

A) 10.1%
B) 10.4%
C) 15.0%
D) 13.2%

Question 28

Which of the following is FALSE regarding negative amortization?

A) It can result in a decrease to the borrower's equity in the property
B) It usually increases default risk
C) It usually has a lower interest rate than a conventional loan
D) It usually results in a lower DCR

Question 29

Which of the following typically would NOT be used as a basis for a participation loan?

A) Increase in value over the holding period
B) NOI in excess of a base amount
C) Cash Flow after regular Debt Service
D) Potential gross income

Question 30

Which of the following would NOT be considered an advantage that an investor might consider under a sale-leaseback of land?

A) The sale-leaseback in effect provides 100% financing on the land
B) Lease payments are tax deductible
C) The sale-leaseback provides the same depreciation deductibility with a smaller equity investment
D) The land may appreciate over the holding period

Question 31

Which of the following is FALSE regarding interest only loans?

A) They usually have balloon payments
B) They have greater amortization than conventional loans
C) They may result in more cash flow to the investor
D) They may allow for a lower DCR

Question 32

A property is financed with a 75% loan at 11.5% over 25 years. The property produces an ATIRR on total investment of 7.34% based on a tax rate of 31%. What can be said about the leverage associated with the property?

A) Negative leverage exists
B) Positive leverage exits
C) No leverage exists
D) Can't tell without knowing the ATIRR on equity

Question 33

A property produces an 8.92% ATIRR on the total investment considering a tax rate of 28%. What is the maximum interest rate that could be paid on debt without causing the leverage to be negative?

A) 12.39%
B) 11.42%
C) 6.42%
D) 9.37%

Question 34

A loan in which the lender has an option to purchase an equity interest in a property is known as an):

A) Participation loan
B) Accrual loan
C) Convertible loan
D) Percentage loan