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Unformatted text preview: lve for PMT of $320k Loan Use Uneven CF to Solve for IBC N = 360 CF0 = 40,000 – 400 = +39,600 I = 0.45 CF1 = 1796.9 – 2221.51 = ‐424.61 PV = 320,000 F1 = 83 PMT = ? = 1,796.90 CF2 = 1796.9 – 2021.51 = ‐224.61 FV = 0 F2 = 277 IRR = 0.76877 x 12 = 9.23 % IBC if Prepayment after 6 years = (Diff in OMB = 289,732 ‐ 325,948 = 36,215) = 11.88% III. Interest‐Rate Risk A. Unanticipated Inflation Erodes Real Value of Scheduled Payments B. Systematic Risk, Difficult to Mitigate as Others Also Exposed C. Interest‐Rate Swaps / Derivatives 1. Purchase “Insurance” Contract Against Future Inflation: Paid Y if Rate Increases to X% 2. Notional Value of IR Swaps: Over $342t in 2009 (only $14t actually exchanged) D. Offer Adjustable Rate Mortgage (ARMs) 1. Basic Idea: Contract Rate Adjust Periodically Based Upon Agreed Index Value Tied to Inflation a) Index: 3rd Party Index That Determines Future Interest Rates Adjustments (i) Constant Yield on 10‐year US Treasury Bond (ii) LIBOR: London Inter‐Bank Offer Rate, Rate at which banks lend to each other b) Adjustment Interval (i) Represents Period Between Adjustments (ii) Range Between Every 6‐months to 3‐years (1 year most common) (iii) More Adjustments = More Interest‐Rate Risk Transferred to Borrower c) Margin: Gap Between...
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- Spring '08