ARE144_chap_04_bf13ed_v2 - 1 Managerial Economics(ARE 144...

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1 Managerial Economics (ARE) 144 University of California, Davis Instructor: John H. Constantine Handout: Chapter 4, Fixed Rate Mortgage Loans NOTES: (1) You should practice using your FINANCIAL CALCULATOR on many of these problems. (2) Many answers have Excel printouts. These are provided to show you how you can use Excel to solve these problems. BUT , you are expected to be able to solve all problems using the given formulas. Detailed answers are provided for many of the questions. In the cases where a full answer is not given, then you can look to a previous answer to get the process to solving. (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? (2) Define amortization. (3) Why do the monthly payments in the beginning months of a CPM loan contain a higher proportion of interest than principal repayment? (4) What are loan closing costs? How can they be categorized? Which of the categories influence borrowing costs and why? (5) Does repaying a loan early ever affect the actual or true interest cost to the borrower? (6) Why do lenders charge origination fees, especially loan discount fees? (7) What is the connection between the Truth-in-Lending Act and the annual percentage rate (APR)? (8) Does the annual percentage rate always equal the effective borrowing cost? (9) What is meant by a real rate of interest? (10) What is a risk premium in the context of mortgage lending? (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? (12) Why do monthly mortgage payments increase so sharply during periods of inflation? What does the tilt effect have to do with this? (13) As inflation increases, the impact of the tilt effect is said to become even more burdensome on borrowers. Why is this so? (14) A mortgage loan is made to Mr. Jones for $30,000 at 10 percent interest for 20 years. If Mr. Jones has a choice between a CPM and a CAM, which one would result in his paying a greater amount of total interest over the life of the mortgage? Would one of these mortgages be likely to have a higher interest rate than the other? Explain your answer. (15) What is negative amortization? Why does it occur with a GPM? What happens to the mortgage balance of a GPM over time?
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2 Problem 1: A borrower obtains a loan for $125,000 at 11 percent interest for 20 years. Interest is compounded monthly. Assume the loan is a CPM. Fill in the table at the end of assignment. The time frame is for six months.
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This note was uploaded on 03/14/2012 for the course ARE 144 taught by Professor Johnson,e during the Spring '08 term at UC Davis.

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ARE144_chap_04_bf13ed_v2 - 1 Managerial Economics(ARE 144...

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