Lecture_400X_MortgageFundII

Lecture_400X_MortgageFundII - Mortgage Fundamentals II:...

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Mortgage Fundamentals II: Adjustable Rate and Variable Payment Mortgages
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ARMs: Rationale To reduce interest rate risk Asymmetric harm across increases and decreases in i. To reduce prepayment risk. Result – interest rates typically lower on ARMs than FRMs.
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Adjustable Rate Mortgage 0 2000 4000 6000 8000 10000 12000 14000 1 61 121 181 241 301 PMT Number $ PMT INT Adjustable Rate Mortgage (ARM): Adjustable Rate Mortgage (ARM): r t r t+s for some s and t. Adjustable Rate Mortgage (ARM) Payments & Interest Component: $1,000,000, 9% Initial Interest, 30-year, monthly payments; 1-year Adjustment interval, possible hypothetical history .
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i = r + p + f Underestimation of any of these components will lead to financial loss for the lender. But how much? Assume 2% unexpected inflation occurs. What will be the financial loss on a $100,000, 30-year fixed- rate mortgage with a 8% interest rate, assuming repayment is expected after 10 years? How do we solve?
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This note was uploaded on 06/08/2011 for the course BUAD 400x at USC.

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Lecture_400X_MortgageFundII - Mortgage Fundamentals II:...

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