Real Estate Finance & Investments 16th Edition by William B Brueggeman – Test Bank

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Real Estate Finance & Investments, 16e (Brueggeman)

Chapter 5   Adjustable and Floating Rate Mortgage Loans

 

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

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

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

 

Answer:  TRUE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

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

 

Answer:  TRUE

Difficulty: 1 Easy

Topic:  PLAMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

4) A major benefit of a PLAM is the mortgage payment increases closely follows borrower salary increases.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  PLAMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

5) PLAMs have been very popular with lenders.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  PLAMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

6) Lender’s can partially avoid estimating interest rates by tying an ARM to an interest rate index.

 

Answer:  TRUE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

7) Negative amortization reduces the principal balance of a loan.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  Negative amortization

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

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

 

Answer:  TRUE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

9) ARMs eliminate all the lender’s interest rate risk.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

10) The default risk of a FRM is higher than the default risk of an ARM.

 

Answer:  FALSE

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

 

11) An ARM may also be referred to as a floating payment loan.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

12) A borrower with an interest-only loan may end up owing more at the end of the loan than the original loan amount.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

13) 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 cap. On the reset date, the composite rate is 5%. What would the Year 3 monthly payment be?

  1. A) $955
  2. B) $1,067
  3. C) $1,071
  4. D) $1,186

 

Answer:  B

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

14) 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 cap. On the reset date, the composite rate is 6%. What would the Year 3 monthly payment be?

  1. A) $955
  2. B) $1,067
  3. C) $1,003
  4. D) $1,186

 

Answer:  D

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

15) 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 cap. On the reset date, the composite rate is 6%. Assume that the loan allows for negative amortization. What would be the outstanding balance on the loan at the end of Year 3?

  1. A) $190,074
  2. B) $192,337
  3. C) $192,812
  4. D) $192,926

 

Answer:  B

Difficulty: 3 Hard

Topic:  ARMs; Negative amortization

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

16) Which is NOT a component of an ARM?

  1. A) A margin
  2. B) An index
  3. C) A chapter
  4. D) Caps

 

Answer:  C

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

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

 

 

  Interest Rate Risk   Default Risk
(A) Higher   Higher
(B) Lower   Lower
(C) Higher   Lower
(D) Lower   Higher

 

 

  1. A) Option A
  2. B) Option B
  3. C) Option C
  4. D) Option D

 

Answer:  D

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

18)

  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.

 

 

Which loan in the above table should have the lowest initial interest rate?

  1. A) Loan 1
  2. B) Loan 2
  3. C) Loan 3
  4. D) Loan 4

 

Answer:  A

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

19)

  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.

 

 

Which loan in the above table is a FRM?

  1. A) Loan 1
  2. B) Loan 2
  3. C) Loan 3
  4. D) Loan 4

 

Answer:  B

Difficulty: 1 Easy

Topic:  FRM

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

20)

  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.

 

 

With which loan in the above table does the lender have the lowest interest rate risk?

  1. A) Loan 1
  2. B) Loan 2
  3. C) Loan 3
  4. D) Loan 4

 

Answer:  A

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

21) Under which scenario is negative amortization likely to occur?

 

 

  Payment Cap   Interest Rates
(A) None   Increasing
(B) None   Decreasing
(C) 7.5%   Increasing
(D) 7.5%   Decreasing

 

 

  1. A) Option A
  2. B) Option B
  3. C) Option C
  4. D) Option D

 

Answer:  C

Difficulty: 2 Medium

Topic:  Negative amortization

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

22) In order to calculate the APR for an ARM, you must,

  1. A) Only use the first year’s given interest rate
  2. B) Estimate interest rates over the life of the loan
  3. C) Assume the worst case scenario and use interest rates at their highest possible point over the life of the loan
  4. 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

 

Answer:  C

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

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

  1. A) Using the same payment as last year and deducting 5% from the principal balance
  2. B) Increasing the payment by 5%
  3. C) Totaling the difference between the payments with the 5% capped payment
  4. D) Compounding the difference between the payments as if no cap existed and with the 5% capped payment

 

Answer:  D

Difficulty: 2 Medium

Topic:  ARMs; Negative amortization

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

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

  1. A) The borrower can choose the cap he wants by simply circling the appropriate choice
  2. B) The interest rate has a 2% annual cap rate and a 5% lifetime cap rate
  3. C) The interest rate has a 5% annual cap rate and a 2% lifetime cap rate
  4. D) The interest rate has a 2% annual cap rate and a 5% floor cap rate

 

Answer:  B

Difficulty: 1 Easy

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

25) Which of the following is a disadvantage of PLAMs?

  1. A) Lenders face high levels of interest rate risk under PLAMs.
  2. B) Fewer homebuyers are likely to qualify for financing using PLAMs in comparison to CPMs.
  3. 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.
  4. D) All of the above.

 

Answer:  C

Difficulty: 2 Medium

Topic:  PLAMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

26) Which of the following clauses leads to higher risk for an ARMs lender?

  1. A) Negative amortization is not allowed when interest is not covered by the payment due to a payment cap
  2. B) There is a floor for payments.
  3. C) Adjustment interval is longer than one year
  4. D) All of the above

 

Answer:  C

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

27) The expected cost of borrowing depends on which of the following provisions?

  1. A) The frequency of payment adjustments
  2. B) The inclusions of caps and floors on the interest rate, payment or loan balances
  3. C) The spread over the index chosen for a given ARM
  4. D) All of the above

 

Answer:  D

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

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

  1. A) An ARM with payment caps and negative amortization
  2. B) An ARM with interest rate caps
  3. C) An ARM with a longer adjustment interval
  4. D) An ARM with no caps or limitations

 

Answer:  D

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

 

29) What is the meaning of the following: Interest is capped at 2%/5%.

  1. A) The loan has a 2% annual cap rate and a 5% lifetime cap rate.
  2. B) The borrower can choose the cap he wants by simply circling the appropriate choice.
  3. C) The loan has a 2% lifetime cap rate and a 5% annual cap rate.
  4. D) The loan has a 2% annual cap rate and a 5% floor cap rate.

 

Answer:  A

Difficulty: 2 Medium

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

 

30) A borrower takes a 30-year, fully amortizing, 5/1 ARM for $225,000 with an initial interest rate of 4.375%. Assuming the index on which the loan rate is based rises by 1% in the fourth year of the loan and remains at that level, what will the payment be in the sixth year of loan?

  1. A) $1,123.39
  2. B) $1,241.89
  3. C) $1,259.94
  4. D) $1,403.71

 

Answer:  B

Explanation:  N = 360; I/Y = 4.375%/12 = 0.3646%; PV = $225,000; FV = $0; CPT PMT = $1,123.39

 

N = 360 − 60 = 300; CPT PV = $204,714.11

 

I/Y = 5.375%/12 = 0.4479%; CPT PMT = $1,241.89

Difficulty: 3 Hard

Topic:  ARMs

Accessibility:  Keyboard Navigation

Gradable:  automatic

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