Financial Markets (Chapter 10)

KYLA R.
DAYAWON BSA-2A
FINANCIAL MARKETS AND INSTITUTIONS
REVIEW QUESTIONS (CHAPTER 10)
1. What distinguishes the mortgage from other capital markets?

- First is the usual borrowers of a capital markets are businesses and government entities, whereas
usual borrowers in the mortgage markets are individuals.
- Second, mortgage loan are made for varying amounts and maturities depending on the borrower’s
needs, features for developing a secondary market.
2. Most Mortgage loans once had balloon payments: Now, most current mortgage loans are fully amortized.
What is the difference between a balloon loan and a fully amortized loan?
- A balloon loans- require that a large payment be made to pay off the remaining balance.
- Fully amortized loans is structured so that equal monthly payment such that the total of all payments
cover both interest and principal over the life of the loan.
3. Give and explain briefly the three important factors that affect the interest rate on the loan.
1. Current long-term market rates. Long term market rates are determined by the supply of and
demand for long-term funds, which are in turn affected by a number of global, national and regional
factors. Mortgages rates tend to stay above the less risky treasury bonds most of the time but tend
to track along with them.
2. Term or Life of the Mortgages. Generally, the longer-term mortgages have higher interest rates
than short-term mortgages. The usual mortgage lifetime is 15 or 30 years. Because interest rate on
the 15-year loan will be substantially less than on the 30-years loan.
3. Number of discounts points paid. Discount points (or simply points) are interest payments made
at the beginning of a loan. A loan with one discount point means that the borrower pays 1% of the
loan amount at closing, the moment when the borrower sign the loan paper and receives the
proceeds of the loan.
4. What features contribute to keeping long-term mortgage interest rate low?

- The global market for loans results in competition that keeps the rates low.
5. Distinguish between conventional mortgage loan and insured mortgage loan.

- Conventional mortgages are originated by banks or other mortgage lenders but are not guaranteed
by government or government controlled entities. Most lenders through now insure many
conventional loans against default or they require the borrower to obtain private mortgage insurance
on loans.
- Insured Mortgages are originated by banks or other mortgage lenders but are guaranteed by either
the Government or Government-Controlled Entities.
6. Describe briefly the following mortgage loans.

(a) Equity Participating Mortgage. In EPM, an outside investor shares in the appreciation of
property. This investor will either provide a portion of the purchase price of the property or
supplement the monthly payment. In return, the investor receives a portion of any appreciation of
property. As with the SAM, the borrower benefits by being able to qualify for a larger loan without
such help.
(b) Shared Appreciation Mortgages (SAMs). In a SAM, the lender lowers the interest rate in the
mortgage in exchange for a share of any appreciation in the real estate (if the property sells for
more than a stated amount, the lender is entitled to a portion of a gain.)
(c) Growing Equity Mortgage (GEMs). With a GEM, the payment will initially be the same as on
conventional mortgage. Over time, the payment will increase. This increase will reduce the
principal more quickly than the conventional payment stream would.
(d) Graduated Payment Mortgages (GPMs). These mortgages are useful for home buyers who
expect their income to rise. The GPM has lower payments in the first few years, then the payment
may not even be sufficient to cover the interest due, in which case the principal balance increases.
As time passes, the borrower expects income to increase so that higher payment will not be too
much of a burden.
(e) Fixed-rate Mortgages. In fixed-rate mortgages, the interest rate and the monthly payment do not
vary over the life of the mortgages.
7. Give the largest providers of funds for mortgage loans.

- Mortgage tools and trust 49%
- Commercial Banks 24%
- Government Agencies and others 15%
- Life insurance companies 9%
- Savings and loans associates 9%
8. What is meant by “securitization of mortgages”?

- Securitization is the process of transforming illiquid financial assets into marketable capital market
instruments. Securitized mortgage are low-risk securities that have higher yield than comparable
government bond and attract funds around the world.
9. Describe the impact of securitized mortgage on the mortgage market.

- Securitized market has reduced the problems and risks caused by regional lending institutions’
sensitivity to local economic fluctuations.
- Borrowers now have access to national capital market.
- Investors can enjoying the low-risk and low-term nature of investing in mortgages without having
to service loan.
- Mortgages rates are now more open to national and international influences. As a consequence,
mortgages rates are more volatile than they were in the past.
10. What is meant by the term underlying as it relatives to derivative financial instruments.
- In derivatives, underlying refers to the similar variables or to the security that must be delivered
when a derivative contract, such as a put or call option, is exercised.
11. What are the main distinctions between a traditional financial instrument and a derivative financial
instrument?
- The differences between traditional and derivative instruments are derivatives are dealt in forward
markets and traditional are not. Derivative instruments include stocks and bonds and other
commodities. Traditional instruments are cash, accounts receivable, and notes payable. Another
difference is that traditional instruments derived value from fair value and derivative instruments
from a value of other assets.
12. In what situation will the unrealized holding gain or loss on a non-trading equity investment be reported
in income?
- If the investment were not hedged, the entire unrealized loss would be included only in the
comprehensive income and reported as a separate component of shareholder’s equity as an
accumulated unrealized loss investment in securities available for sale.
13. A
14. B
15. A
16. A

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KYLA R.

REVIEW QUESTIONS (CHAPTER 10)

1. What distinguishes the mortgage from other capital markets?

4. What features contribute to keeping long-term mortgage interest rate low?

5. Distinguish between conventional mortgage loan and insured mortgage loan.

6. Describe briefly the following mortgage loans.

7. Give the largest providers of funds for mortgage loans.

8. What is meant by “securitization of mortgages”?

9. Describe the impact of securitized mortgage on the mortgage market.

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