Real Estate Finance and Investments 15th Edition By Brueggeman – Test Bank

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CHAPTER 5

Adjustable and Floating Rate Mortgage Loans

 

TRUE/FALSE

 

  1. ARMs were developed because lenders were tired of offering a limited selection of loan alternatives to borrowers. (F)

 

  1. ARMs help lenders combat unanticipated inflation changes, interest rate changes, and a maturity gap. (T)

 

  1. Characteristics of a PLAM include an increasing mortgage payment and an adjusting loan balance tied to an index. (T)

 

  1. A major benefit of a PLAM is the mortgage payment increases closely following borrower salary increases. (F)

 

  1. PLAMs have been very popular with lenders. (F)

 

  1. Lender’s can partially avoid estimating interest rates by tying an ARM to an interest rate index. (T)

 

  1. Negative amortization reduces the principal balance of a loan. (F)

 

  1. The floor of an ARM is the maximum reduction of payments or interest rates allowed. (T)

 

  1. ARMs eliminate all the lender’s interest rate risk. (F)

 

  1. The default risk of a FRM is higher than the default risk of an ARM. (F)

 

 

MULTIPLE CHOICE

 

  1. A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a “teaser” rate of 4%, after that, the rate can reset with a 2% annual rate On the reset date, the composite rate is 5%. What would the Year 3 monthly payment be? (B)

 

  • $955
  • $1,067
  • $1,071
  • $1,186
  • Because of the rate cap, the payment would not change.

 

  1. A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a “teaser” rate of 4%, after that, the rate can reset with a 5% annual payment On the reset date, the composite rate is 6%. What would the Year 3 monthly payment be? (C)

 

  • $955
  • $1,067
  • $1,003
  • $1,186
  • Because of the payment cap, the payment would not change.

 

  1. Assume that the loan in the previous question allowed for negative amortization. What would be the outstanding balance on the loan at the end of Year 3? (B)

 

  • $190,074
  • $192,337
  • $192,812
  • $192,926

 

  1. Which of the following statements regarding negative amortization in the previous question is true? (D)

 

  • The Year 3 payments are less than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is higher than at the end of Year 2.
  • The Year 3 payments are more than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is higher than at the end of Year 2.
  • The Year 3 payments are less than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is lower than at the end of Year 2.
  • The Year 3 payments are more than the interest assessed on the loan, so the outstanding balance at the end of Year 3 is lower than at the end of Year 2.

 

  1. Which is NOT a component of an ARM? (C)

 

(A) A margin

(B) An index

(C) A chapter

(D) Caps

 

  1. Which of the following descriptions most accurately reflects the risk position of an ARM lender in comparison to that of a FRM lender? (D)

 

Interest Rate Risk       Default Risk

(A)       Higher                         Higher

(B)       Lower                          Lower

(C)       Higher                         Lower

(D)       Lower                          Higher

 

   

LOAN 1

 

LOAN 2

 

LOAN 3

 

LOAN 4

Initial Interest Rate ? ? ? ?
Loan Maturity (years) 20 20 20 20
% Margin Above Index 3% 3% 3%
Adjustment Interval 1 yr. 1 yr. 1 yr.
Points 1% 1% 1% 1%
Interest Rate Cap NONE —- 1%/yr. 3%/yr.

 

  1. Which loan in the above table should have the lowest initial interest rate? (A)

 

(A) Loan 1

(B) Loan 2

(C) Loan 3

(D) Loan 4

  1. Which loan in the above table is a FRM? (B)

 

(A) Loan 1

(B) Loan 2

(C) Loan 3

(D) Loan 4

 

  1. With which loan in the above table does the lender have the lowest interest rate risk? (A)

 

(A) Loan 1

(B) Loan 2

(C) Loan 3

(D) Loan 4

 

  1. Under which scenario is negative amortization likely to occur? (C)

 

Payment Cap              Interest Rates

(A)       None                           Increasing

(B)       None                           Decreasing

(C)       7.5%                            Increasing

(D)       7.5%                            Decreasing

 

  1. In order to calculate the APR for an ARM, you must, (C)

 

(A) Only use the first year’s given interest rate

(B) Estimate interest rates over the life of the loan

(C) Assume the worst case scenario and use interest rates at their highest possible point over the life of the loan

(D) Use only the first five year’s interest rates because they can easily be estimated and most people only own a property for five years

 

  1. If an ARM index increased 15%, the negative amortization on a loan with a 5% annual payment cap is calculated by: (D)

 

(A) Using the same payment as last year and deducting 5% from the principal balance

(B) Increasing the payment by 5%

(C) Totaling the difference between the payment as if no cap existed and the 5% capped payment

(D) Compounding the difference between the payment as if no cap existed and the 5% capped payments

 

  1. If one of the terms of an ARM read, interest is capped at 2%/5%, what would that mean? (B)

 

(A) The borrower can choose the cap he wants by simply circling the appropriate choice

(B) The interest rate has a 2% annual cap rate and a 5% lifetime cap rate

(C) The interest rate has a 5% annual cap rate and a 2% lifetime cap rate

(D) The interest rate has a 2% annual cap rate and a 5% floor cap rate

 

  1. Which of the following is a disadvantage of PLAMs? (C)

 

(A) Lenders face high levels of interest rate risk under PLAMs.

(B) Fewer homebuyers are likely to qualify for financing using PLAMs in comparison to CPMs.

(C) The price level used to index PLAMs is measured on an ex post basis and historic prices may not be an accurate reflection of future price.

(D) All of the above.

 

  1. Which of the following clauses leads to higher risk for an ARMs lender? (C)

 

(A) Negative amortization is not allowed when interest is not covered by the payment due to a payment cap

(B) There is floor for payments

(C) Adjustment interval is longer than one year

(D) All of the above

 

  1. The expected cost of borrowing does NOT depend on which of the following provisions? (D)

 

(A) The frequency of payment adjustments

(B) The inclusions of caps and floors on the interest rate, payment or loan balances

(C) The spread over the index chosen for a given ARM

(D) None of the above

 

  1. Given that every other factor is equal, which of the following ARMs will have the lowest expected cost? (D)

 

(A) An ARM with payment caps and negative amortization

(B) An ARM with interest rate caps

(C) An ARM with longer Adjustment interval

(D) An ARM with no caps or limitations

 

 

 

CHAPTER 17

Financing Land Development Projects

 

TRUE/FALSE

 

  1. Option contracts are used to reserve a parcel of land so that it will not be sold to someone else, while the developer does preliminary analysis of the site. (T)

 

  1. Lenders typically insist on a loan repayment rate that equal to the rate for which parcels are expected to sell. (F)

 

  1. The release price is the dollar amount of a loan that must be repaid when a lot is sold. (T)

 

  1. A feasibility study analyzes whether a tract can be purchased and developed profitably. (T)

 

  1. An option contract does not preclude the landowner from selling the property to someone else after the expiration date. (T)

 

  1. The release schedule refers to a schedule of expiring leases for existing tenants. (F)

 

  1. By using an option contract, a developer may profit from an appreciation in the property’s value over the option period. (T)

 

  1. In most instances, a developer’s repayment rate is set so that the development loan will be repaid at the exact point that 100% of total project revenue is realized. (F)

 

  1. It is proper to include an estimate for developer profit as a cost of development when projecting net cash flows and evaluating whether a required rate of return will be met. (F)

 

  1. Usually, a lender does not require a developer to submit a schedule of estimated cash flows prior to approving a land development loan. (F)

 

  1. A developer must sell all of the lots in a development project and repay the entire development loan before any of the new property owners can receive a clear title. (F)

 

  1. In order to obtain a land development loan, the developer is required usually to purchase title insurance. (T)

 

  1. It is common for a developer to hold back funds to be sure that subcontractors perform all work completely before making final payment. (T)

 

  1. It is illegal for the lender to hold back funds from the developer. (F)

 

 

MULTIPLE CHOICE

 

Total sales revenue $10,000,000
Less: Development cost 6,000,000
Less: Land asking price 1,000,000
Potential gross profit $3,000,000
Less: Admin., legal, commissions, etc. 1,500,000
Potential net profit $1,500,000

 

  1. Consider the feasibility study shown in the table above. What is the return on total cost for the proposed project? (A)

 

  • 0%
  • 6%
  • 4%
  • 0%

 

  1. Refer to the information in the previous question. You have been advised that sales revenues may be 10 percent lower and/or development costs may be 10 percent higher. Performing a sensitivity analysis, you conclude: (A)

 

  • A 10 percent decrease in sales revenues would have a bigger impact on returns than a 10 percent increase in development costs
  • A 10 percent increase in development costs would have a bigger impact on returns than a 10 percent decrease in sales revenues
  • A 10 percent increase in development costs and a 10 percent decrease in sales revenues would have opposite impacts on returns, canceling each other out and having no impact on returns
  • Both factors would have such a small impact, that there is no reason to be concerned about either a 10 percent increase in development costs or a 10 percent decrease in sales revenues

 

 

Month Construction
Draw
Sales
Revenue
1 $200,000  
2 150,000  
3 75,000  
4 25,000 $600,000
     
Total $450,000 $600,000
Present value @ 12% $441,883 $576,588

 

  1. Consider the table above, which summarizes monthly construction draws and sales revenues. What is the percent of lot sales revenue that needs to be used to repay the loan? (C)

 

  • 0%
  • 0%
  • 6%
  • 3%

 

  1. The land development industry is best characterized by which of the following statements? (B)

 

(A) The land development industry is dominated by relatively few national competitors

(B) The land development industry is highly fragmented, localized, and extremely competitive

(C) Land development and project development are synonymous

(D) The production technologies and market risks involved in land development are essentially the same as those in project development

 

  1. Which of the following is the MOST LIKELY sequence of events in the land development process? (C)

 

(A) Inspect site, perform feasibility analysis, implement marketing program, purchase land and begin construction of improvements

(B) Inspect site, purchase land and begin construction of improvements, perform feasibility analysis, implement marketing program

(C) Inspect site, perform feasibility analysis, purchase land and begin construction of improvements, implement marketing program

(D) Purchase land, perform feasibility analysis, perform preliminary market study, begin construction of improvements, implement marketing program

 

  1. Generally, which of the following is FALSE regarding an option contract? (C)

 

(A) An option contract allows the developer to perform a preliminary market study and feasibility analysis

(B) If the developer decides to purchase a property, the price of an option is applied towards the price of the property

(C) If the developer decides not to purchase the property, the landowner will refund any money paid for the option

(D) An option contract provides the developer with the assurance that a property will not be sold over the course of the option period

 

  1. Each parcel of land in a new development is selling for $15,000 and the total project revenue is estimated to be $5,000,000. The project lender has stated that the loan should be paid off when 80% of the total project revenue has been earned.  The total loan amount is $3,500,000.  What is the release price for each parcel? (B)

 

(A) $8,400

(B) $13,215

(C) $18,750

(D) None of the above

 

  1. Which of the following might impact the density of housing in a land development project? (D)

 

(A) The price paid for the land by the developer

(B) The terrain of the land

(C) The target market’s preferences regarding density

(D) All of the above

 

  1. Which of the following costs should NOT be included in a net present value analysis of a land development project? (D)

 

(A) Land purchase price

(B) Property tax

(C) General overhead such as personnel costs

(D) Developer’s profit

 

  1. When financing land development, the lender generally requires the developer to submit which of the following? (D)

 

(A) A detailed breakdown of project cost

(B) Required zoning changes

(C) Bank references for the general contractor to be used on the project

(D) All of the above

 

  1. A transaction in which two firms trade individual financing advantages to produce more favorable borrowing terms for each is know as a(n): (A)

 

(A) Interest rate swap

(B) Sequential short hedge

(C) Cross hedge

(D) All of the above

 

  1. A futures instrument, such as a T-bill, can be used to hedge a cash or a spot instrument such as the prime rate, where the two instruments are not perfectly correlated. What type of hedge is this referred to as? (C)

 

(A) A perfect hedge

(B) A straight hedge

(C) A cross hedge

(D) None of the above

 

  1. Generally, which of the following is FALSE regarding interest rate risk management techniques? (D)

 

(A) Borrowers can protect themselves from upward movements in interest rates by using interest rate caps

(B) Borrowers can protect themselves from upward movements in interest rates by using interest rate futures contracts

(C) Borrowers can benefit from downward movements in interest rates by using interest rate caps

(D) Borrowers can benefit from downward movements in interest rates by using interest rate futures contracts

 

  1. An analysis of whether land can be purchased and developed profitably is known as: (B)

 

(A) Financial analysis

(B) Feasibility study

(C) Turnkey study

(D) Project profitability

 

  1. The amount to be paid to the lender from each lot sale is included in the: (A)

 

(A) Release schedule

(B) Development agreement

(C) Cost breakdowns

(D) Subcontracts

  1. Which of the following was NOT stated as contributing to the complication of estimating amount of interest carry? (D)

 

(A) The loan is drawn and interest is calculated on drawn amount

(B) Revenue from each type of site varies

(C) The rate of repayment of a loan depends on when the parcel is sold

(D) Development loan interest rates are usually fixed while market rates fluctuate

 

  1. Which of the following is FALSE regarding the release price? (A)

 

(A) It is usually calculated to pay off the loan when the last lot is sold

(B) It is usually calculated to pay off the loan before the last lot is sold

(C) Increasing the release price usually lowers the lender’s risk

(D) Increasing the release price is likely to lower the investor’s initial cash flow

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