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Distinguish the mortgage markets from other capital markets

Financial Markets and Institutions (8th Edition) (Pearson Series in Finance) 8th Edition by Frederic S Mishkin (Author), Stanley Eakins (Author) Chapter 14

Questions

  1.  What distinguishes the mortgage markets from other capital markets?
  2.  What kind of insurance do lenders usually require of borrowers who have less than 80% loan-to-value ratios?
  3. Lenders tend not to be as flexible about the qualifications required of mortgage customers as they can be of other types of bank loans. Why is this so?

Problems

  1.  Compute the required monthly payment on an $80,000 30-year fixed-rate mortgage with a nominal interest rate of 5.80%. How much of the payment goes toward principal and interest during the first year?
  2. Consider a 5-year balloon loan for $100,000.  The bank requires a monthly payment equal to that of a 30-year fixed-rate loan with a nominal annual rate of 5.5%. How much will the borrower owe when the balloon payment is due?
  3. Consider the following options available to a mortgage borrower:
Option Loan Amount Interest Rate (%) Type of Mortgage Discount Points
1 $100,000 6.75 30-yr fixed 0
2 $150,000 6.25 30-yr fixed 1
3 $125,000 6.0 30-yr fixed 2

What is the effective rate for each option?

  1.  Two mortgage options are available: a 30-yr fixed-rate loan at 6% with no discount points, and a 30-year fixed-rate loan at 5.75% with 1 discount point.  How long do you have to stay in the house for the mortgage with points to be a better option?  Assume a $100,000 mortgage.

Part II: Other Questions

Question 1: Earlier in the semester we discussed the following three goals of the financial system:

  1. Facilitate transfers of funds from savers to investors

    2. Facilitate sharing of risks

    3. Provide liquidity

Question 1a: How do MBS’s (Mortgage Backed Securities) achieve these goals?

Question 1b: Do you think 30-yr mortgages would be liquid without securitization?

Question 1c: To the extent that the US  government backs (explicitly or implicity) mortgage backed securities issued by Fannie Mae, Freddie Mac and Ginnie Mae, do you think that the 30-yr mortgage market could remain liquid without government intervention?

Question 2: Read the 2013 WSJ article entitled “Fannie, Freddie Future Finds a Focus.”

URL    http://www.wsj.com/articles/SB10001424127887324021104578549682228860970?alg=y

Question 2a: In your opinion, should Congress replace Fannie Mae and Freddie Mac, should it fix them, or should it simply eliminate them? Explain.

Question 2b: Do you think the market for 30-year fixed-rate mortgages would remain liquid without government intervention? Why or why not?

Question 2c: Why do you think the terms of Freddie and Fannie’s bailout doesn’t allow them to pay off any of the $188 billion they owe? Should the $132 billion already paid as preferred dividends be allowed to count as repayment of the loans? Why or why not?

 

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