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CH 7 - 8 - BUS 171A Exam 2 CH1 CH8 Review Risk of...

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BUS 171A 10/23/2008 Exam 2 10/30/2008 CH1 – CH8 Review Risk of ARM (Adjustable Rate Mortgage) vs. Fixed Rates ARM is better for lender Fixed is better for borrower Balloon Payment – Little payments in the beginning and a large lump sum at the end of the period. FI – Profit vs. term structure of interest rates (Yield Curve) R(lend) – r(borrow) = Profit Upward Sloping of the yield curve the FI borrow short and lend long FNMA (Fmaie Mae) – Federal National Mortgage Association - 1938 as a government agency - Made as a secondary mortgage lender. 1968 old FNMA become two. - New FNMA a. Used to be Government sponsored enterprise b. The new FNMA is privately owned. - GNMA (Ginnie mae) a. government owned FHLM (Freddie Mae) – Government owned and privately owned (Conservatorship) Risks of investing in mortgages 1. Default (No repayment of principal or interest 2. Liquidity 3. Price (due to interest rat changes – or overall market risk) 4. Prepayment
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Pass through security CMO/CDO Collaterized Mortgage (debt) obligations Tranches (slices) A pool of debt, 100 million coupon 7.5% per year, 5 years tranches: 4
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