Deck 9: Mortgage Markets

Question 1

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.

Answer 1

C

Question 2

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 2

A

Question 3

The interest rate on a second mortgage is ____ the rate on a first mortgage created at the same time, because the second mortgage is ____ the existing first mortgage in priority claim against the property in 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

Answer 3

A

Question 4

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

Question 5

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

Question 6

Which of the following was part of the U.S. government's response to the credit crisis?

A)Troubled Asset Relief Program (TARP)
B)Housing and Economic Recovery Act
C)Homeowners' Mortgage Guarantee  Act
D)Troubled Asset Relief Program (TARP)AND  Housing and Economic Recovery Act

Question 7

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 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

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 10

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 11

Mortgage companies, commercial banks, and savings institutions are the primary originators of mortgages.

Question 12

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

Question 13

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 14

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 these are correct.

Question 15

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 16

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

A)Freddie Mac
B)Ginnie Mae
C)Fannie Mae
D)None of these are correct.

Question 17

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 18

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

Question 19

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 20

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 these are very common.

Question 21

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 22

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-payment mortgages.
C)invested only in prime mortgages that offered very low returns.
D)invested heavily in subprime mortgages.

Question 23

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

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

Question 24

____ 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 25

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 26

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

Question 27

A mortgage contract specifies

A)the interest rate.
B)the collateral backing the loan.
C)whether the interest rate is fixed or adjustable.
D)the maturity.
E)all of the above.

Question 28

A financial institution may service a mortgage even after selling it.

Question 29

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 30

___ economic growth will probably ____ the risk premium on mortgages and cause the price of mortgages in the secondary market to _____.

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

Question 31

Which of the following was a major contributor to the credit crisis?

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

Question 32

____ mortgages enable 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 33

Mortgage-backed securities are assigned ratings by

A)rating agencies.
B)the U.S. Treasury
C)the Federal Reserve.
D)the mortgage originator.

Question 34

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 these are correct.

Question 35

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 these are guarantors of federally insured mortgages.

Question 36

Which of the following are important criteria that financial institutions consider when assessing the creditworthiness of a prospective borrower for a mortgage?

A)the down payment the borrower will make
B)the borrower's debt-to-income ratio
C)the borrower's credit score
D)all of the above

Question 37

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

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

Question 38

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

Question 39

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

Question 40

A balloon-payment mortgage requires only 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 41

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

Question 42

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

Question 43

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 mortgage price to decrease.

Question 44

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

Question 45

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

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

Question 46

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

Question 47

Mortgages are rarely sold in the secondary market.

Question 48

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)higher; longer AND lower; shorter

Question 49

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

Question 50

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-term mortgage loans.

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

Question 51

A(n)_________ 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 52

Strong economic growth tends to reduce the probability that borrowers will default on their mortgage payments and therefore tends to decrease mortgage prices.

Question 53

American International Group (AIG)was a huge _______ of credit default swaps (CDS)that offered protection against mortgage defaults, so when many mortgages defaulted during the credit crisis, AIG was obliged to _______.

A)seller; repurchase the CDS contracts it had sold
B)buyer; sell its CDS contracts to raise capital
C)buyer; surrender its CDS contracts to the Federal Reserve
D)seller; make large payments to the buyers of the CDS contracts

Question 54

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

A)primary
B)secondary
C)money
D)None of these are correct.

Question 55

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

Question 56

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 debt-to-income level.
D)the borrower's credit score.
E)Credit risk is affected by all of these.

Question 57

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 58

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 59

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

Question 60

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

A)It is similar to a graduated-payment mortgage.
B)The monthly payments on the mortgage are initially small.
C)The monthly payments increase throughout the life of the mortgage.
D)The monthly payments increase for the first 5 to 10 years of the mortgage and then level off.

Question 61

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

Question 62

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

Question 63

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 that are covered by a credit default swap, the price of the contract should be _______ related to the default risk as it changes over time.

A)​p ositively; positively
B)positively; inversely
C)Inversely; positively
D)inversely; inversely

Question 64

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