Week 7

Question 1

Securitization mostly in the US through MBS (Mortgage-Backed Securities). Why in the US only? Why did securitization arise?

Answer 1

In the U.S., the securitization of mortgages is intricately linked to the ability to efficiently manage defaults and foreclosures. When a significant portion of mortgages default, the legal and financial systems in the U.S. are structured to handle foreclosures and repossessions more efficiently than in many other countries

Question 2

Fixed-rate mortgages (FRMs) typically have higher interest rates than adjustable-rate mortgages (ARMs). True/False

Answer 2

True

Question 3

When the interest rate spread between FRMs and ARMs is large, more borrowers choose what?

Answer 3

When the interest rate spread between FRMs and ARMs is large, more borrowers choose ARMs due to the significantly lower interest rates compared to FRMs.

Question 4

Empirical evidence suggests that a household is more likely to choose an adjustable
rate mortgage (ARM) rather than a fixed rate mortgage (FRM) when the
(a) FRM-ARM spread

Answer 4

FRM-ARM spread is high and bond risk premium (5 year minus 1 year
Treasuries) is high

Question 5

What types of interest rates affect FRM and ARM

Answer 5

FRM more affected by long term interest rate where ARM more affected by short term interest rate

Question 6

Household decision rule

Answer 6

Household decision rule is the difference between five year Treasury yield and the three year moving average of the one year Treasury yield. * When this rises, long term interest rates are high, FRMs therefore become more expensive from the point of view of the households and ARM share rises.

Question 7

When bond risk premium high, explain what happens to FRM and ARM

Answer 7

When bond risk premium high, FRM payments high, making ARMs more attractive

Question 8

So, in an inflationary environment, homeowners with fixed-rate mortgages renters - who wins and loses

Answer 8

Renter vs Homeowner:

Homeowners with a fixed-rate mortgage of 5% benefit when inflation is 10% because the real value of their mortgage payments decreases, making it easier to afford.
Renters suffer when inflation rises because their rent payments increase, and their income does not rise as quickly.