Assignment 9 Intro to Motgage Finance

Question 1

Which one of the following statements regarding the supply of mortgage funds is TRUE?

1. A decrease in the demand for stocks (traded in the capital market) will decrease the mortgage fund supply.
2. Changes in government policies always have a direct and significant impact on the supply of mortgage funds.
3. The supply of mortgage funds is dependent on the total amount of savings available and its competitive position.
4. The mortgage market and the capital market are unrelated.

Answer 1

Correct Answer: 3

Option (3) is correct because the supply of mortgage funds is dependent on the total amount of saving available and its competitive position.

Option (1) is incorrect because an increase in demand in the capital market decreases the mortgage fund supply.

Option (2) is incorrect because changes in government policies are important in determining the supply of mortgage funds. However, they do not always have a direct or significant impact.

Option (4) is incorrect because the mortgage market is linked with the capital market as each has a share of the total supply of savings.

Question 2

Which one of the following statements regarding interest rates in the capital market is TRUE?

1. Usually, the longer the term of the investment, the lower the interest must be paid to the investor.
2. The more risk an investment poses, the higher the rate of interest charged.
3. Due to the very low risk present with a government bond, there is no capital risk associated with it.
4. Second or third mortgages are more secure investments than first mortgages.

Answer 2

Correct Answer: 2

Option (2) is correct because the more risk an investment poses, the higher the rate of interest charged.

Option (1) is incorrect because a higher interest must be paid to the investor to induce them to lock in the funds, for longer term investments. Although government bonds have a very low risk present, there is capital risk present. However, the only capital risk is price fluctuation before the date the bond is redeemed and the possibility of a fall in the value of money. Therefore, Option (3) is incorrect.

Option (4) is incorrect because second or third mortgages are less secure investments than first mortgages. Therefore, second mortgages require higher interest rates.

Question 3

Which one of the following statements regarding interest accruing loans is TRUE?

1. The lender is actually “borrowing” money back from the borrower.
2. Interest accruing loans are usually written for terms of more than two years.
3. No payments of interest or principal are made during the life of the loan.
4. The entire original investment by the lender is rarely at risk throughout the life of the loan.

Answer 3

Correct Answer: 3

Option (3) is correct because no payments of interest or principal are made during the life of an interest accruing loan.

Option (1) is incorrect because interest accruing loans effectively require the lender to lend the borrower additional amounts of money equal to the amount of interest due during the life of the loan.

Option (2) is incorrect because almost all interest accruing loans are written for short terms, one year or less.

Option (4) is incorrect because the lender receives no payments before the maturity of the loan; therefore, the entire original investment is at risk throughout the term of the loan.

Question 4

Which one of the following statements regarding the sources of mortgage funds is TRUE?

1. Both federal and provincial governments provide mortgage loans.
2. Most mortgage loans are initiated by private lenders.
3. The life insurance industry remains the most important source of mortgage funds in Canada.
4. Chartered banks are currently one of the smallest sources of institutional mortgage funds in Canada.

Answer 4

Correct Answer: 1

Option (1) is correct; federal and provincial governments provide mortgage loans.

Option (2) is incorrect because most mortgage loans are not initiated by private lenders.

Option (3) is incorrect because the life insurance industry is not a significant source of mortgage funds in Canada.

Option (4) is incorrect because chartered banks are the largest source of institutional mortgage funds in Canada.

Question 5

Which one of the following statements regarding the outstanding principal of a loan is TRUE?

1. The outstanding principal of an interest accruing loan will increase at an increasing rate throughout the term of the loan.
2. The outstanding principal of a standard constant payment loan will decrease at a constant rate.
3. The outstanding principal of a straight-line principal reduction loan will decrease at a variable rate.
4. The outstanding principal of an interest only loan remains constant throughout the term of the loan.

Answer 5

Correct Answer: 4

Option (4) is correct because the outstanding principal of an interest only loan remains constant throughout the term of the loan.

Option (1) is incorrect because the outstanding principal of an interest accruing loan will remain constant throughout the term of the loan since the entire principal amount is advanced at the beginning of the loan (refer to Figure 13.5).

Option (2) is incorrect because the outstanding principal of a standard constant payment loan will decrease at an increasing rate (refer to Figure 13.8).

Option (3) is incorrect because the outstanding principal of a straight line principal reduction loan will decrease at a constant rate.

Question 6

Sam is inquiring why some mortgage loan borrowers choose fixed rate mortgages over variable rate mortgages. Which of the following is NOT an appropriate explanation?

1. Fixed rate mortgage rates generally move in tandem with bond rates.
2. Variable rate mortgages are considered higher risk to borrowers than fixed rate mortgages because variable rate mortgage rates fluctuate with changes in the prime rate.
3. Mortgage loan borrowers are often incentivized by variable rate mortgages’ increased risk and payment variability.
4. Fixed rate borrowers have no risk of their mortgage payment increasing during the contractual term, making fixed rate mortgages lower risk for borrowers.

Answer 6

Correct Answer: 3

Option (3) is correct because consumers are often disincentivized by the added risk and increased payment variability of variable rate mortgages.

Options (1), (2), and (4) are appropriate explanations why borrowers would choose fixed rate mortgages over variable rate mortgages. The interest rate charged on fixed rate mortgages generally move in tandem with bond yields and deposit rates of similar maturity, which reflects expectations of inflation [Option (1)].

Fixed rate mortgages have no risk of the mortgage payment increasing as the interest rate remains fixed during the term [Option (4)]. However, with variable rate mortgages, the interest rate “floats” with the prime rate, increasing payment variability and risk for mortgage loan borrowers [Option (2)].

Question 7

Which one of the following statements regarding mortgage repayment plans is TRUE?

1. An open mortgage prevents individual borrowers from prepaying their mortgage without penalty, except where they are permitted under the terms of their mortgage contract or by the Interest Act.
2. A variable rate mortgage differs from a fixed rate mortgage because the interest rate charged on the variable rate loan may be changed during the term of the mortgage.
3. With a vendor take-back mortgage, if the contract rate is the same as the market rate, the perceived market value of the mortgage will always be different than the market value of the mortgage.
4. A key feature of a graduated payment mortgage is that the accumulated principal advances and interest are repaid by refinancing, by sale of the property, or from proceeds of the borrower’s estate at the end of the term or upon the death of the borrower.

Answer 7

Correct Answer: 2

Option (2) is correct; a variable rate mortgage differs from a fixed rate mortgage because the interest rate charged on the variable rate mortgage may be changed during the term of the mortgage.

Option (1) is incorrect because an open mortgage allows (not prevents) borrowers to prepay a portion of their mortgage or the entire amount at any time, typically with a small administrative fee.

Option (3) is incorrect because with a vendor take-back mortgage, if the contract rate is the same as the market rate, the perceived market value of the mortgage will the same as the market value of the mortgage.

Option (4) is incorrect because it is a reverse annuity mortgage (not a graduated payment mortgage) where, at the end of the loan term or upon the death of the borrower, the loan balance, consisting of the accumulated principal advances and the interest due, is repaid by refinancing, by sale of the property, or from the proceeds of the borrower’s estate.

Question 8

Which one of the following mortgage repayment plans is distinguished by the ability of borrowers switching between fixed and variable interest rate periods within a contractual term?

1. Graduated payment mortgage
2. Improvement mortgage
3. Reverse annuity mortgage
4. Combination mortgage

Answer 8

Correct Answer: 4

Option (4) is correct because combination mortgages are characterized by their ability to switch between a fixed and variable interest rate. It is often thought of as having two payment periods: fixed and variable. Therefore, Options (1), (2), and (3) are incorrect.

Graduated payment mortgages offer lower payment options at the start of the term, that gradually increase with time. This enables more mortgage loan borrowers to qualify as the initial lower payment options increase their affordability [Option (1)].

Improvement mortgages enable borrowers to purchase property, renovate it, and pay for it with as little as a 5-10% down payment. The down payment is the lower of the ‘as improved price’ or the purchase price plus the improvement costs [Option (2)].

Reverse annuity mortgages are often used to supplement older home owner’s income as the lender pays the borrower advances over the term. After the borrower passes, the mortgage loan is financed by the sale of the property of from proceeds of the borrower’s estate. [Option (3)].

Question 9

Why are mortgage rates from banks in Canada generally quoted with semi-annual compounding?

1. In order to comply with the federal Interest Act
2. So that compounding frequency matches payment frequency
3. In order to comply with the Real Estate Services Act
4. All of the above

Answer 9

Correct Answer: 1

Option (1) is correct and Options (2), (3), and (4) are incorrect because, in Canada, a provision of the federal Interest Act requires the annual rate of interest to be quoted in a mortgage contract with either annual or semi-annual compounding. Usually, semi-annual compounding is quoted rather than annual compounding because it results in interest rates that appear to be lower than those based on annual compounding.

Question 10

Which one of the following statements is TRUE of an individual borrower’s prepayment rights, as stated in the federal Interest Act?

1. The borrower has the right to tender all of the outstanding debt, with an additional three months’ interest in lieu of notice, at any time after five years from the initial date of the mortgage.
2. The borrower has the right to tender all of the outstanding debt at any time during the term of the mortgage contract.
3. The borrower may be legally bound to a mortgage contract with a clause included stating “absolutely no prepayment whatsoever until the end of the 10-year term”.
4. The borrower has no right of prepayment at any point during the term of a mortgage

Answer 10

Correct Answer: 1

Option (1) is correct and Options (2), (3), and (4) are incorrect because under the terms of the Interest Act, borrowers have the right to tender payment on the total outstanding debt, with an additional three months’ interest as a penalty, at any time after five years from the initial date of the mortgage.

The borrower may not be legally bound to a mortgage contract clause that allows no prepayment rights when the mortgage term is greater than five years.

Question 11

There is a new multi-family real estate project construction in the metro Vancouver area. After analyzing the different aspects of the real estate in the Vancouver area, the management of Alpha Ltd. believes this to be a great investment opportunity. They decide to make a total investment of $2,500,000 in this project. Out of that total amount, they decide to fund part of this investment via an interest accruing loan for $200,000, at 6% per annum, compounded semi-annually for a period of 2 years. What is the total amount due at the end of the loan term? Round your final answer to the nearest dollar.

1. $225,102
2. $256,000
3. $205,240
4. $204,073

Answer 11

Correct Answer: 1

Option (1) is correct because the total amount due at the end of the 2-year term is $225,102, rounded to the nearest dollar.

PRESS

DISPLAY

6 I/YR

6

2 ⬛ P/YR

2

4 N

4

0 PMT

0

200000 PV

200,000

FV

–225,101.762

Question 12

Which of the following is NOT one of the mortgage investment vehicles designed to increase the supply of mortgage funds and to ease access to the mortgage market for small investors?

1. Canada mortgage bonds
2. Mortgage investment corporations
3. Mortgage hedging options
4. Mortgage-backed securities

Answer 12

Correct Answer: 3

Option (3) is correct because a mortgage hedging option is not a mortgage investment vehicle that exists in Canada to increase mortgage supply and ease access of the mortgage market to small investors.

Options (1), (2), and (4) are incorrect because Canada mortgage bonds, mortgage investment corporations, and mortgage-backed securities are all investment vehicles discussed in the manual that help to increase mortgage supply and ease access to the mortgage market for small investors.

Question 13

Your friend approached you and offered you an investment that is expected to produce $300,000 in 60 months. If you want to earn 5% per annum, compounded monthly, how much should you offer to pay for the investment today, rounded to the nearest dollar?

1. $288,675
2. $204,859
3. $233,762
4. $432,769

Answer 13

Correct Answer: 3

Option (3) is correct because the present value of this investment is $233,762, rounded to the nearest dollar.

PRESS
DISPLAY

5 I/YR

5

12 ⬛ P/YR

12

300000 FV

300,000

60 N

60

0 PMT

0

PV

–233,761.617095

Question 14

After receiving a scholarship for $100,000, you decide to deposit that money in an account bearing an interest rate of 4% per semi-annual compounding period. You intend to let the interest accrue on the deposit and then invest the total amount in real estate. If the funds are deposited today for a three-year period, what will be the amount available at the end of this period, rounded to sthe nearest dollar?

1. $194,198
2. $174,026
3. $126,532
4. $184,349

Answer 14

Option (3) is correct because the future value of this investment is $126,532, rounded to the nearest dollar.

PRESS
DISPLAY

8 I/YR

8

2 ⬛ P/YR

2

100000 +/- PV

–100,000

6 N

6

0 PMT

0

FV

126,531.90185

Question 15

Which one of the following statements regarding periodic and nominal interest rates is TRUE?

1. A monthly periodic rate (imo) of 2% is equivalent to a nominal rate of j12 = 12%.
2. A daily periodic rate (id) of 0.025% is equivalent to a nominal rate of j365 = 9.125%.
3. A semi-annual periodic rate (isa) of 2.5% is equivalent to a nominal rate of j2 = 9%.
4. A quarterly periodic rate (iq) of 3.25% is equivalent to a nominal rate of j4 = 10.5%.

Answer 15

Correct Answer: 2

Option (2) is correct because a daily periodic rate of 0.025% is equivalent to a nominal rate of j365 = 9.125%. This question requires the periodic rates given to be converted to their nominal equivalent rates and compared. Since jm = j × m, then:

j12 = 2 × 12 = 24%
j365 = 0.025 × 365 = 9.125%
j2 = 2.5 × 2 = 5%
j4 = 3.25 × 4 = 13%

Question 16

Kendra has been collecting empty bottles and cashing them in for money at regular intervals. She receives 15 cents for each bottle and collects an average of 500 bottles per week. The market rate of interest is j52 = 5%. How much will Kendra have at the end of one year (rounded to the nearest dollar) if she deposits her earnings into a savings account (earning j52 = 5%) at the end of each week?

1. $3,997
2. $3,183
3. $3,840
4. $3,665

Answer 16

Option (1) is correct because Kendra will have $3,997 in her savings account at the end of one year. Kendra collects $75 each week (500 × 0.15) and deposits this money into a savings account earning 5% per annum, compounded weekly. Calculate the future value of these payments.

PRESS
DISPLAY

5 I/YR

5

52 ⬛ P/YR

52

500 × .15 =

75

+/- PMT

–75

52 N

52

0 PV

0

FV

3,997.17567

Question 17

Kendra would like to put aside some money into her savings account so that she can purchase a minivan to haul the bottles she collects. If Kendra could set aside $30 at the end of every week and the savings account earns interest at j52 = 4%, how much money will have accumulated in the savings account by the end of the 7th year, rounded to the nearest dollar?

1. $11,301
2. $10,867
3. 14,482
4. $12,597

Answer 17

Option (4) is correct because Kendra will have $12,597 in her savings account at the end of 7 years. Kendra sets aside $30 each week and deposits this money into a savings account earning 4% per annum, compounded weekly. Calculate the future value of these payments at the end of 7 years (7 years × 52 weeks = 364 weeks).

PRESS
DISPLAY

4 I/YR

4

52 ⬛ P/YR

52

30 +/– PMT

–30

52 × 7 = N

364

0 PV

0

FV

12,596.508683

Question 18

Cameron has received $550 as a birthday gift from friends and wants to use the money in exactly 2 years to pay $1,000 for a new laptop computer. Cameron has deposited the money in an account bearing a periodic interest rate of 0.4% per month, compounded monthly. Will Cameron have enough money to pay for the laptop computer in two years? Round your final answer to the nearest dollar.

1. No, Cameron will be $212 short.
2. No, Cameron will be $36 short.
3. Yes, Cameron will have enough money.
4. No, Cameron will be $395 short.

Answer 18

Correct Answer: 4

Option (4) is correct because Cameron will be $395 short. To calculate the amount Cameron will have in the account at the end of two years, enter the $550 deposit amount as the present value and calculate the future value after 24 months (12 months × 2 years) at the given interest rate of j12 = 4.8% (0.4% × 12 months).

PRESS

DISPLAY

0.4 × 12 = I/YR

4.8

12 ⬛ P/YR

12

12 × 2 = N

24

0 PMT

0

550 +/- PV

–550

FV

605.301565

Cameron will have $605 in the account at the end of two years. If Cameron needs $1,000 to buy the laptop computer, there will be a deficit of $395 ($1,000 – $605).

Question 19

Jamie has received an interest only loan for $925,000, which will be used to help build a new veterinary clinic. The loan has an interest rate of 6.5% per annum, compounded quarterly, and requires quarterly interest only payments. If the loan term is for two years, how much is the quarterly interest only payment that Jamie makes?

1. $18,476.34
2. $15,031.25
3. $16,784.14
4. $17,934.25

Answer 19

Correct Answer: 2

Option (2) is correct because the interest only payment is $15,031.25. Since you never pay down the principal balance on an interest only loan, the present value and the future value will be the same. In an interest only loan, you can set N to equal any number because there is no principal portion of the payments paying down the loan, and each payment will be the interest portion of the loan.

PRESS
DISPLAY

6.5 I/YR

6.5

4 ⬛ P/YR

4

925000 PV

925,000

925000 +/- FV

–925,000

1 N

1

PMT

–15,031.25

Question 20

The Grovers have been granted an interest only loan for $275,000 to purchase a boat for their fishing charter business. The term of the loan is 2 years, and the contract rate of interest is 0.8% per month. What will be the amount of the second monthly payment?

1. $2,200
2. $1,050
3. $226,050
4. $277,000

Answer 20

Correct Answer: 1

Option (1) is correct because with an interest only loan, all periodic payments until the end of the term of the loan are interest payments and are identical. The monthly payment for the Grover’s loan is $2,200 ($275,000 × 0.008).