Solutions to Questions - Chapter 4 Fixed Rate Mortgage Loans

4680 Words Apr 6th, 2012 19 Pages
Solutions to Questions - Chapter 4
Fixed Rate Mortgage Loans

Question 4-1 What are the major differences between the CAM, and CPM loans? What are the advantages to borrowers and risks to lenders for each? What elements do each of the loans have in common? CAM - Constant Amortization Mortgage - Payments on constant amortization mortgages are determined first by computing a constant amount of each monthly payment to be applied to principal. Interest is then computed on the monthly loan balance and added to the monthly amount of amortization to determine the total monthly payment. CPM - Constant Payment Mortgage - This payment pattern simply means that a level, or constant, monthly payment is calculated on an original
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Question 4-9 What is meant by a real rate of interest? A real rate of interest is an interest rate expressed in terms of real goods and is equal to the nominal rate less the expected rate of inflation.

Question 4-10 What is a risk premium in the context of mortgage lending? A reason for loan discount fees is that lenders believe that they can better price the loan to the risk they take. The risk for some individual borrowers is slightly higher than others and these loans may require more time and expense to process and control.

Question 4-11 When mortgage lenders establish interest rates through competition, an expected inflation premium is said to be part of the interest rate. What does this mean? The uncertainty of future economic factors, including the supply of savings, demand for housing and future levels of inflation, directly affects interest rates. However, interest rates at a given point in time can only reflect the market consensus of what these factors are expected to be. To be competitive, a lender can only charge an interest rate that reflects what the market expects inflation to be even if he expects inflation to more.

Question 4-12 Why do monthly mortgage payments increase so sharply during periods of inflation? What does the tilt effect have to do with this? In order to receive the full interest necessary to leave enough for a real return and risk premium over the life of the loan, more “real

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