Real Estate Finance & Investments, 16e (Brueggeman)
1) ARMs were developed because lenders were tired of offering a limited selection of loan
alternatives to borrowers.
2) ARMs help lenders combat unanticipated inflation changes, interest rate changes, and a
maturity gap.
3) Characteristics of a PLAM include an increasing mortgage payment and an adjusting loan
balance tied to an index.
4) A major benefit of a PLAM is the mortgage payment increases closely follows borrower
salary increases.
5) PLAMs have been very popular with lenders.
6) Lender’s can partially avoid estimating interest rates by tying an ARM to an interest rate
index.
7) Negative amortization reduces the principal balance of a loan.
8) The floor of an ARM is the maximum reduction of payments or interest rates allowed.
9) ARMs eliminate all the lender’s interest rate risk.
10) The default risk of a FRM is higher than the default risk of an ARM.
11) An ARM may also be referred to as a floating payment loan.
12) A borrower with an interest-only loan may end up owing more at the end of the loan than the
original loan amount.
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?
A) $955
B) $1,067
C) $1,071
D) $1,186
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?
A) $955
B) $1,067
C) $1,003
D) $1,186
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?
A) $190,074
B) $192,337
C) $192,812
D) $192,926
16) Which is NOT a component of an ARM?
A) A margin
B) An index
C) A chapter
D) Caps
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
A) Option A
B) Option B
C) Option C
D) Option D
18)
LOAN 1
LOAN 2
LOAN 3
Initial Interest Rate
?
?
?
Loan Maturity (years)
20
20
20
% Margin Above Index
3%
—
3%
Adjustment Interval
1 yr.
—
1 yr.
Points
1%
1%
1%
Interest Rate Cap
NONE
—
1%/yr.
Which loan in the above table should have the lowest initial interest rate?
A) Loan 1
B) Loan 2
C) Loan 3
D) Loan 4
19)
LOAN 1
LOAN 2
LOAN 3
Initial Interest Rate
?
?
?
Loan Maturity (years)
20
20
20
% Margin Above Index
3%
—
3%
Adjustment Interval
1 yr.
—
1 yr.
Points
1%
1%
1%
Interest Rate Cap
NONE
—
1%/yr.
Which loan in the above table is a FRM?
A) Loan 1
B) Loan 2
C) Loan 3
D) Loan 4
20)
LOAN 1
LOAN 2
LOAN 3
Initial Interest Rate
?
?
?
Loan Maturity (years)
20
20
20
% Margin Above Index
3%
—
3%
Adjustment Interval
1 yr.
—
1 yr.
Points
1%
1%
1%
Interest Rate Cap
NONE
—
1%/yr.
With which loan in the above table does the lender have the lowest interest rate risk?
A) Loan 1
B) Loan 2
C) Loan 3
D) Loan 4
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
A) Option A
B) Option B
C) Option C
D) Option D
22) In order to calculate the APR for an ARM, you must,
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
23) If an ARM index increased 15%, the negative amortization on a loan with a 5% annual
payment cap is calculated by:
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 payments with the 5% capped payment
D) Compounding the difference between the payments as if no cap existed and with the 5%
capped payment
24) If one of the terms of an ARM read, interest is capped at 2%/5%, what would that mean?
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
25) Which of the following is a disadvantage of PLAMs?
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.
26) Which of the following clauses leads to higher risk for an ARMs lender?
A) Negative amortization is not allowed when interest is not covered by the payment due to a
payment cap
B) There is a floor for payments.
C) Adjustment interval is longer than one year
D) All of the above
27) The expected cost of borrowing depends on which of the following provisions?
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) All of the above
28) Given that every other factor is equal, which of the following ARMs will have the lowest
expected cost?
A) An ARM with payment caps and negative amortization
B) An ARM with interest rate caps
C) An ARM with a longer adjustment interval
D) An ARM with no caps or limitations
29) What is the meaning of the following: Interest is capped at 2%/5%.
A) The loan has a 2% annual cap rate and a 5% lifetime cap rate.
B) The borrower can choose the cap he wants by simply circling the appropriate choice.
C) The loan has a 2% lifetime cap rate and a 5% annual cap rate.
D) The loan has a 2% annual cap rate and a 5% floor cap rate.
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?
A) $1,123.39
B) $1,241.89
C) $1,259.94
D) $1,403.71