Deck 9: Mortgage Markets

Question 1

Caps on mortgage rate fluctuations with adjustable-rate mortgages (ARMs) are typically

A) 2 percent per year and 5 percent for the mortgage lifetime.
B) 5 percent per year and 15 percent for the mortgage lifetime.
C) 0 percent per year and 10 percent for the mortgage lifetime.
D) 3 percent per year and 8 percent for the mortgage lifetime.

Answer 1

A

Question 2

An institution that originates and holds a fixed-rate mortgage is adversely affected by ____ interest rates; the borrower who was provided the mortgage is adversely affected by ____ interest rates.

A) stable; decreasing
B) increasing; stable
C) increasing; decreasing
D) decreasing; increasing

Answer 2

C

Question 3

A financial institution has a higher degree of interest rate risk on a ____ than a ____.

A) 30-year fixed-rate mortgage; 15-year fixed-rate mortgage
B) 30-year variable-rate mortgage; 30-year fixed-rate mortgage
C) 15-year fixed-rate mortgage; 30-year fixed-rate mortgage
D) 15-year variable-rate mortgage; 15-year fixed-rate mortgage

Answer 3

A

Question 4

At a given point in time, the interest rate offered on a new fixed-rate mortgage is typically ____ the initial interest rate offered on a new adjustable-rate mortgage.

A) below
B) above
C) equal to
D) all of the above are very common

Question 5

____ was created in 1968 as a corporation that is wholly owned by the federal government. It guarantees payment on mortgages that meet specific criteria.

A) Freddie Mac
B) Ginnie Mae
C) Fannie Mae
D) None of the above

Question 6

Federally insured mortgages guarantee

A) loan repayment to the lending financial institution.
B) that the interest rate will not increase during the life of the mortgage.
C) the lending financial institution a selling price for the mortgage in the secondary market.
D) all of the above

Question 7

A mortgage that requires interest payments for a three- to five-year period, then full payment of principal, is a(n)

A) chattel mortgage.
B) balloon-payment mortgage.
C) variable-rate mortgage.
D) open-ended mortgage bond.

Question 8

A mortgage with low initial payments that increase over time without ever leveling off is a

A) graduated payment mortgage.
B) growing-equity mortgage.
C) second mortgage.
D) shared-appreciation mortgage.

Question 9

Rates for adjustable-rate mortgages are commonly tied to the

A) average prime rate over the previous year.
B) Fed's discount rate over the previous year.
C) average Treasury bill rate over the previous year.
D) average Treasury bond rate over the previous year.

Question 10

Mortgage-backed securities are commonly contained within collateralized debt obligations.

Question 11

A balloon-payment mortgage requires interest payments for a 10- to 20-year period, at the end of which the borrower must pay the full amount of the principal.

Question 12

The difference between the 30-year mortgage rate and the 30-year Treasury bond rate is primarily attributable to

A) interest rate risk.
B) reinvestment rate risk.
C) credit risk.
D) insurance risk.

Question 13

A ____ mortgage allows the borrower to initially make small payments on the mortgage. The payments then increase over the first 5 to 10 years and then level off.

A) graduated-payment mortgage
B) growing-equity mortgage
C) second mortgage
D) shared-appreciation mortgage

Question 14

The interest rate on a second mortgage is ____ on a first mortgage created at the same time, because the second mortgage is ____ the existing first mortgage in priority claim against the propertyin the event of default.

A) higher than; behind
B) equal to that; equal to
C) lower than; ahead of
D) higher than; ahead of
E) lower than; behind

Question 15

Use an amortization schedule. A 15-year $100,000 mortgage has a fixed mortgage rate of 9 percent. In the first month, the total mortgage payment is $____, and $____ of this amount representspayment of interest.

A) 1,014; 264
B) 1,241; 750
C) 1,014; 750
D) none of the above

Question 16

Mortgage companies specialize in

A) purchasing mortgages originated by other financial institutions.
B) investing and maintaining mortgages that they create.
C) originating mortgages and selling those mortgages.
D) borrowing money through the creation of mortgages that is used to invest in real estate.

Question 17

From the perspective of the lending financial institution, interest rate risk is

A) lower on a 30-year fixed-rate mortgage than on a 15-year fixed-rate mortgage.
B) lower on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage.
C) higher on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage.
D) higher on a 15-year adjustable-rate mortgage than on a 30-year adjustable-rate mortgage.

Question 18

"Securitization" refers to the private insurance of conventional mortgages.

Question 19

Which of the following mortgages allows the home purchaser to obtain a mortgage at a below-market interest rate throughout the life of the mortgage?

A) second mortgage
B) growing-equity mortgage
C) graduated-payment mortgage
D) shared-appreciation mortgage

Question 20

For any given interest rate, the shorter the life of the mortgage, the ____ the monthly payment and the ____ the total payments over the life of the mortgage.

A) greater; greater
B) greater; lower
C) lower; greater
D) lower; lower

Question 21

Which of the following is not a guarantor of federally insured mortgages?

A) Federal Housing Administration (FHA)
B) Veterans Administration (VA)
C) Federal Deposit Insurance Corporation (FDIC)
D) All of the above are guarantors of federally insured mortgages.

Question 22

Mortgage lenders normally charge a higher initial interest rate on adjustable-rate mortgages than on fixed-rate mortgages.

Question 23

____ mortgages enabled more people with relatively lower income, or high existing debt, or a small down payment to purchase homes.

A) Prime
B) Balloon
C) Amortized
D) Subprime

Question 24

When financial institutions originate residential mortgages, the mortgage contract should not specify

A) whether the mortgage is federally insured.
B) the amount of the loan.
C) whether the interest rate is fixed or adjustable.
D) the maturity.
E) the mortgage contract should specify all of the above

Question 25

A balloon-payment mortgage requires interest payments for a three- to five-year period. At the end of this period, full payment of the principal (the balloon payment) is required.

Question 26

Regardless of what happens to market interest rates, most adjustable-rate mortgages (ARMs) specify a maximum allowable fluctuation in the mortgage rate per year and over the mortgage life.

Question 27

In a collateralized mortgage obligation (CMO), mortgages are segmented into ____ (or classes).

A) balloon payments
B) caps
C) tranches
D) strips

Question 28

An adjustable-rate mortgage increases interest rate risk for the ____, but reduces interest rate risk for the ____.

A) originator; borrower
B) borrower; originator
C) government; originator
D) none of the above

Question 29

During the early years of a mortgage, most of the monthly payment reflects principal.

Question 30

___ economic growth will probably ____ the risk premium on mortgages and ____ the price of mortgages.

A) Strong; increase; decrease
B) Strong; increase; increase
C) Weak; decrease; increase
D) Weak; increase; increase
E) Weak; decrease; decrease

Question 31

A ____ mortgage allows borrowers to initially make small payments on the mortgage, which are then increased on a graduated basis over the first five to ten years; payments then level off fromthere on.

A) balloon-payment
B) graduated-payment
C) shared-appreciation
D) growing-equity
E) none of the above

Question 32

Fannie Mae and Freddie Mac experienced financial problems during the credit crisis because they:

A) were unwilling to finance new mortgages.
B) invested heavily in balloon mortgages.
C) invested only in prime mortgages that offered very low returns.
D) invested heavily in subprime mortgages.

Question 33

Which of the following is not a common type of mortgage-backed security according to your text?

A) participation certificates (PCs)
B) collateralized mortgage obligations (CMOs)
C) balloon-payment mortgage certificates
D) private-label pass-through securities
E) All of the above are common types of mortgage pass-through securities.

Question 34

An increase in either the risk-free rate or the risk premium on a fixed-rate mortgage results in a higher required rate of return when investing in the mortgage and therefore causes the mortgageprice to decrease.

Question 35

Some adjustable-rate mortgages (ARMs) contain an option clause that allows mortgage holders to switch to a fixed-rate mortgage within a specified period.

Question 36

Mortgages are rarely sold in the secondary market.

Question 37

____ risk is the risk that a borrower may prepay the mortgage in response to a decline in interest rates.

A) Interest rate
B) Credit
C) Prepayment
D) Reinvestment rate

Question 38

The secondary mortgage market accommodates originators of mortgages who desire to sell their mortgages before maturity.

Question 39

Mortgage-backed securities are assigned ratings by:

A) rating agencies.
B) the Treasury.
C) the Fed.
D) the mortgage originator.

Question 40

The credit crisis is mostly attributed to the use of:

A) strict criteria applied by mortgage originators.
B) liberal criteria applied by mortgage originators.
C) very tough credit ratings applied to mortgages.
D) fixed-rate mortgages with long terms to maturity.

Question 41

Which of the following is not true with respect to a growing-equity mortgage?

A) It is similar to a graduated-payment mortgage
B) It allows borrowers to initially make small payments on the mortgage.
C) It involves increased payments, on a graduated basis, over the first five to ten years of the mortgage.
D) It involves payments that level off after the first five to ten years of the mortgage.

Question 42

Speculators sell credit default swaps to benefit from the default of specific subprime mortgages.

Question 43

From the perspective of the lending financial institution, there is a ____ degree of interest rate risk for ____-maturity mortgages.

A) higher; shorter
B) higher; longer
C) lower; shorter
D) lower; higher
E) Answers B and C are correct

Question 44

Non-U.S. financial institutions never hold mortgages on U.S. property.

Question 45

The ____ market accommodates originators of mortgages that desire to sell their mortgages prior to maturity.

A) primary
B) secondary
C) money
D) none of the above

Question 46

The probability that a borrower will default (credit risk) is influenced by all of the following, except

A) economic conditions.
B) the level of equity invested by the borrower
C) the borrower's income level.
D) the borrower's credit history.
E) Credit risk is affected by all of the above.

Question 47

A __________ is a privately negotiated contract that protects investors against the risk of default on particular debt securities such as mortgage-backed securities.

A) default insurance contract
B) default risk swap
C) credit default swap
D) collateralized debt obligation

Question 48

Financial institutions that hold fixed-rate mortgages in their asset portfolios are exposed to ____ risk, because they commonly use funds obtained from short-term customer deposits to make long#NAME?erm mortgage loans.

A) exchange rate
B) prepayment
C) reinvestment rate
D) interest rate
E) exchange rate

Question 49

In the earlier years of a mortgage,

A) most of the monthly payment reflects principal reduction.
B) most of the monthly payment reflects interest.
C) about half of the monthly payment reflects interest.
D) all of the monthly payment reflects principal reduction.

Question 50

Financial institutions may sell credit default swaps on mortgages if they expect defaults on many mortgages.

Question 51

The valuation of mortgage-backed securities is difficult because of limited
transparency.

Question 52

The higher the level of equity invested by the borrower, the higher the probability that the loan will default.

Question 53

Which of the following is not a correct description of qualified mortgages?

A) They must comply with regulations issued by the Consumer Financial Protection Bureau.
B) Their term cannot exceed 30 years.
C) They cannot be interest-only mortgages or result in negative amortization.
D) They must be retained by the lending institution that originated the mortgages and cannot be sold.
E) They place limits on the borrower's debt-to-income ratio.

Question 54

An investor in interest-only collateralized mortgage obligations (CMOs) would not be concerned that homeowners will prepay the underlying mortgages.

Question 55

_________ problem occurs when a person or institution does not have to bear the full consequences of its behavior and therefore assumes more risk than it otherwise would.

A) asymmetric information
B) moral hazard
C) risk adjustment
D) specific hazard

Question 56

Borrowers who have a lower level of income relative to the periodic loan payments are more likely to default on their mortgages.

Question 57

Financial institutions may purchase credit default swaps on mortgages if they expect defaults on many mortgages.

Question 58

Which of the following will typically require homeowners to ultimately request a new mortgage?

A) graduated-payment mortgage (GPM)
B) growing-equity mortgage
C) balloon-payment mortgage
D) shared-appreciation mortgage

Question 59

In a short sale of a home:

A) the lender forecloses and then sells the home for less than what is owed on the mortgage.
B) the lender allows the homeowner to sell the home for less than what is owed on the mortgage.
C) the lender does not recover the full amount of the mortgage.
D) B and C
E) A and C

Question 60

Strong economic growth tends to reduce the probability that the issuer of a mortgage will default on its debt payments and therefore tends to decrease mortgage prices.

Question 61

Bear Stearns commonly used __________ as collateral when borrowing short-term funds, but its funding was cut off because prospective creditors questioned the quality of the collateral.

A) commercial paper
B) Treasury securities
C) its stock
D) mortgages

Question 62

At a given point in time, the price of a credit default swap contract should be ________ related to the default risk of the securities covered by the contract. For a given set of securities thatare covered by a credit default swap, the price of the contract should be _______ related to the default risk as it changes over time.

A) positively; positively
B) positively; inversely
C) Inversely; positively
D) inversely; inversely

Question 63

Lehman Brothers commonly used _________ as collateral when borrowing short-term funds, but its funding was cut off because prospective creditors questioned the quality of the collateral.

A) commercial paper
B) Treasury securities
C) its stock
D) mortgages