Financial Markets and Institutions, 6e (Mishkin/Eakins)
Chapter 12 The Mortgage Markets
12.1 Multiple Choice
1) Which of the following are important ways in which mortgage markets differ from the stock
and bond markets?
A) The usual borrowers in the capital markets are government entities and businesses,
whereas the usual borrowers in the mortgage markets are individuals.
B) Most mortgages are secured by real estate, whereas the majority of capital market
borrowing is unsecured.
C) Because mortgages are made for different amounts and different maturities,
developing a secondary market has been more difficult.
D) All of the above are important differences.
E) Only A and B of the above are important differences.
2) Which of the following are important ways in which mortgage markets differ from stock and
bond markets?
A) The usual borrowers in capital markets are government entities, whereas the usual
borrowers in mortgage markets are small businesses.
B) The usual borrowers in capital markets are government entities and large businesses,
whereas the usual borrowers in mortgage markets are small businesses.
C) The usual borrowers in capital markets are government entities and large businesses,
whereas the usual borrowers in mortgage markets are small businesses and
individuals.
D) The usual borrowers in capital markets are businesses and government entities,
whereas the usual borrowers in mortgage markets are individuals.
3) Which of the following are true of mortgages?
A) A mortgage is a long–term loan secured by real estate.
B) A borrower pays off a mortgage in a combination of principal and interest payments
that result in full payment of the debt by maturity.
C) Over 80 percent of mortgage loans finance residential home purchases.
D) All of the above are true of mortgages.
E) Only A and B of the above are true of mortgages.
4) Which of the following are true of mortgages?
A) A mortgage is a long–term loan secured by real estate.
B) Borrowers pay off mortgages over time in some combination of principal and interest
payments that result in full payment of the debt by maturity.
C) Less than 65 percent of mortgage loans finance residential home purchases.
D) All of the above are true of mortgages.
E) Only A and B of the above are true of mortgages.
5) Which of the following are true of mortgages?
A) Prior to the 1920s, U.S. banking legislation discouraged mortgage lending by banks.
B) In the 1920s, most mortgages were balloon loans, which required the borrower to pay
the entire loan amount after three to five years.
C) Because mortgages are long–term loans secured by real estate, mortgage lenders tended
to fail when land prices declined, as was often the case during economic recessions.
D) All of the above are true.
E) Only A and B of the above are true.
6) Which of the following is true of mortgage interest rates?
A) Interest rates on mortgage loans are determined by three factors: current long–term
market rates, the term of the mortgage, and the number of discount points paid.
B) Mortgage interest rates tend to track along with Treasury bond rates.
C) The interest rate on 15–year mortgages is lower than the rate on 30–year mortgages, all
else the same.
D) All of the above are true.
E) Only A and B of the above are true.
7) Which of the following are true of mortgages?
A) More than 80 percent of mortgage loans finance residential home purchases.
B) The National Banking Act of 1863 rewarded banks that increased mortgage lending.
C) Most mortgages during the 1920s and 1930s were balloon loans.
D) All of the above are true.
E) Only A and C of the above are true.
8) Which of the following is true of mortgage interest rates?
A) Longer–term mortgages have lower interest rates than shorter–term mortgages.
B) Mortgage rates are lower than Treasury bond rates, because of the tax–deductibility of
mortgage interest rates.
C) In exchange for points, lenders reduce interest rates on mortgage loans.
D) All of the above are true.
E) Only A and B of the above are true.
9) Typically, discount points should not be paid if the borrower will pay off the loan in
_________ years or less.
A) 5
B) 10
C) 15
D) 20
10) Which of the following is true of mortgage interest rates?
A) Longer–term mortgages have higher interest rates than shorter–term mortgages.
B) In exchange for points, lenders reduce interest rates on mortgage loans.
C) Mortgage rates are lower than Treasury bond rates because of the tax deductibility of
mortgage interest payments.
D) All of the above are true.
E) Only A and B of the above are true.
11) Which of the following reduces moral hazard for the mortgage borrower?
A) Collateral
B) Down payments
C) Private mortgage insurance
D) Borrower qualifications
12) Which of the following protects the mortgage lender’s right to sell property if the underlying
loan defaults?
A) A lien
B) A down payment
C) Private mortgage insurance
D) Borrower qualification
E) Amortization
13) Which of the following is true of mortgage interest rates?
A) Mortgage rates are closely tied to Treasury bond rates, but mortgage rates tend to stay
below Treasury rates because mortgages are secured with collateral.
B) Longer–term mortgages have higher interest rates than shorter–term mortgages.
C) Interest rates are higher on mortgage loans on which lenders charge points.
D) All of the above are true.
E) Only A and B of the above are true.
14) During the early years of an amortizing mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal
balance.
15) During the last years of an amortizing mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal
balance.
16) During the last years of a balloon mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal
balance.
17) During the early years of a balloon mortgage loan, the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal
balance.
18) A borrower who qualifies for an FHA or VA loan enjoys the advantage that
A) the mortgage payment is much lower.
B) only a very low or zero down payment is required.
C) the cost of private mortgage insurance is lower.
D) the government holds the lien on the property.
19) (I) Conventional mortgages are originated by private lending institutions, and FHA or VA
loans are originated by the government. (II) Conventional mortgages are insured by private
companies, and FHA or VA loans are insured by the government.
A) (I) is true, (II) is false.
B) (I) is false, (II) is true.
C) Both are true.
D) Both are false.
20) Borrowers tend to prefer _________ to _________, whereas lenders prefer _________
A) fixed–rate loans; ARMs; fixed–rate loans.
B) ARMs; fixed–rate loans; fixed–rate loans.
C) fixed–rate loans; ARMs; ARMs.
D) ARMs; fixed–rate loans; ARMs.
21) (I) ARMs offer lower initial rates and the rate may fall during the life of the loan. (II)
Conventional mortgages do not allow a borrower to take advantage of falling interest rates.
A) (I) is true, (II) is false.
B) (I) is false, (II) is true.
C) Both are true.
D) Both are false.
22) Growing–equity mortgages (GEMs)
A) help the borrower pay off the loan in a shorter time.
B) have such low payments in the first few years that the principal balance increases.
C) offer borrowers payments that are initially lower than the payments on a conventional
mortgage.
D) do all of the above.
E) do only A and B of the above.
23) A borrower with a 30–year loan can create a GEM by
A) simply increasing the monthly payments beyond what is required and designating that
the excess be applied entirely to the principal.
B) converting his ARM into a conventional mortgage.
C) converting his conventional mortgage into an ARM.
D) converting his conventional mortgage into a GPM.
24) Which of the following are useful for home buyers who expect their income to rise in the
future?
A) GPMs
B) RAMs
C) GEMs
D) Only A and B are useful.
E) Only A and C are useful.
25) Which of the following are useful for home buyers who expect their income to fall in the
future?
A) GPMs
B) RAMs
C) GEMs
D) Only A and B are useful.
E) Only A and C are useful.
26) Retired people can live on the equity they have in their homes by using a
A) GEM.
B) GPM.
C) SAM.
D) RAM.
27) Second mortgages serve the following purposes:
A) they give borrowers a way to use the equity they have in their homes as security for
another loan.
B) they allow borrowers to get a tax deduction on loans secured by their primary
residence or vacation home.
C) they allow borrowers to convert their conventional mortgages into GEMs.
D) all of the above.
E) only A and B of the above.
28) Which of the following is a disadvantage of a second mortgage compared to credit card
debt?
A) The loans are secured by the borrower’s home.
B) The borrower gives up the tax deduction on the primary mortgage.
C) The borrower must pay points to get a second mortgage loan.
D) The borrower will find it more difficult to qualify for a second mortgage loan.
29) The share of the mortgage market held by savings and loans is approximately
A) 50 percent.
B) 40 percent.
C) 20 percent.
D) 10 percent.
30) The share of the mortgage market held by commercial banks is approximately
A) 50 percent.
B) 25 percent.
C) 15 percent.
D) 5 percent.
31) Which of the following has not been a reason for the development and growth of online
mortgage lending?
A) Mortgage lending is an information–based service and no products have to be
inventoried or shipped.
B) The product (a mortgage loan) is homogeneous.
C) It has led to simplification of loan alternatives and made comparison shopping easier.
D) Online lenders have lower overhead and can offer loans at lower costs.
32) A loan–servicing agent will
A) package the loan for an investor.
B) hold the loan in their investment portfolio.
C) collect payments from the borrower.
D) A and C.
E) B and C.
33) Distinct elements of a mortgage loan include
A) origination.
B) investment.
C) servicing.
D) all of the above.
E) only B and C.
34) The Federal National Mortgage Association (Fannie Mae)
A) was set up to buy mortgages from thrifts so that these institutions could make more
loans.
B) funds purchases of mortgages by selling bonds to the public.
C) provides insurance for certain mortgage contracts.
D) all of the above.
E) only A and B of the above.
35) The Federal Housing Administration (FHA)
A) was set up to buy mortgages from thrifts so that these institutions could make more
loans.
B) funds purchases of mortgages by selling bonds to the public.
C) provides insurance for certain mortgage contracts.
D) all of the above.
E) only A and B of the above.
36) _________ issues participation certificates, and _________ provides federal insurance for
participation certificates.
A) Freddie Mac; Freddie Mac
B) Freddie Mac; Ginnie Mae
C) Ginnie Mae; Freddie Mac
D) Ginnie Mae; Ginnie Mae
E) Freddie Mac; no one
37) REMICs are most like
A) Freddie Mae pass–through securities.
B) Ginnie Mae pass–through securities.
C) participation certificates.
D) collateralized mortgage obligations.
38) Ginnie Mae
A) insures qualifying mortgages.
B) insures pass–through certificates.
C) insures collateralized mortgage obligations.
D) A and B.
E) B and C.
39) All of the following add to concerns about the safety and soundness of Fannie Mae and
Freddie Mac except their
A) large publicly issued debt relative to that of the federal government.
B) political influence.
C) high capital–asset ratio that gives rise to conflicts of interest.
D) multiple goals of profit maximization and working to further the public interest.
40) Mortgage–backed securities
A) have been growing in popularity in recent years as institutional investors look for
attractive investment opportunities.
B) are securities collateralized by a pool of mortgages.
C) are securities collateralized by both insured and uninsured mortgages.
D) all of the above.
E) only A and B of the above.
41) The most common type of mortgage–backed security is
A) the mortgage pass–through, a security that has the borrower’s mortgage payments pass
through the trustee before being disbursed to the investors.
B) collateralized mortgage obligations, a security which reduces prepayment risk.
C) the participation certificate, a security which passes the borrower‘s mortgage payments
equally among all the owners of the certificates.
D) the securitized mortgage, a security which increases the liquidity of otherwise illiquid
mortgages.
42) The interest rate borrowers pay on their mortgages is determined by
A) current long–term market rates.
B) the term.
C) the number of discount point.
D) all of the above.
43) A loan for borrowers who do not qualify for loans at the usual market rate of interest
because of a poor credit rating or because the loan is larger than justified by their income is
A) a subprime mortgage.
B) a securitized mortgage.
C) an insured mortgage.
D) a graduated–payment mortgage.
44) The percentage of the total loan paid back immediately when a mortgage loan is obtained
and lowers the annual interest rate on the debt is called
A) discount points.
B) loan terms.
C) collateral.
D) down payment.
45) Which of the following terms are found in mortgage loan contracts to protect the lender
from financial loss?
A) Collateral
B) Down payment
C) Private mortgage insurance
D) All of the above
46) What factors are used in determining a person’s FICO score?
A) Past payment history
B) Outstanding debt
C) Length of credit history
D) All of the above
47) What new debt instruments compete for funds with government bonds, corporate bonds,
and stocks that are low–risk securities that have higher yields than comparable government
bonds and attract funds from around the world?
A) Subprime mortgages
B) Private pass–throughs
C) Securitized mortgages
D) Mortgage–backed mutual funds
12.2 True/False
1) Down payments are designed to reduce the likelihood of default on mortgage loans.
2) Discount points (or simply points) are interest payments made at the beginning of a loan.
3) A point on a mortgage loan refers to one monthly payment of principal and interest.
4) Closing for a mortgage loan refers to the moment the loan is paid off.
5) Private mortgage insurance is a policy that guarantees to make up any discrepancy between
the value of the property and the loan amount, should a default occur.
6) During the early years of the loan, the lender applies most of the payment to the principal on
the loan.
7) One important advantage to a borrower who qualifies for an FHA or VA loan is the very low
interest rate on the mortgage.
8) Adjustable–rate mortgages generally have lower initial interest rates than do fixed–rate
mortgages.
9) Mortgage interest rates loosely track interest rates on three–month Treasury bills.
10) An advantage of a graduated–payment mortgage is that borrowers will qualify for a larger
loan than if they requested a conventional mortgage.
11) Nearly half the funds for mortgage lending come from mortgage pools and trusts.
12) Many institutions that make mortgage loans do not want to hold large portfolios of long–
term securities, because it would subject them to unacceptably high interest–rate risk.
13) A problem that initially hindered the marketability of mortgages in a secondary market was
that they were not standardized.
14) Mortgage–backed securities have declined in popularity in recent years as institutional
investors have sought higher returns in other markets.
15) Mortgage–backed securities are marketable securities collateralized by a pool of mortgages.
16) Fannie Mae and Freddie Mac together either own or insure the risk on nearly one–fourth of
America’s residential mortgages.
17) A FICO score below 660 is considered good while a score above 720 is likely to cause
problems in obtaining a loan.
18) Subprime loans are those made to borrowers who do not qualify for loans at the usual
market rate of interest because of a poor credit rating or because the loan is larger than
justified by their income.
19) Securitized mortgages are low–risk securities that have higher yields than comparable
government bonds and attract funds from around the world.
12.3 Essay
1) How has the modern mortgage market changed over recent years?
2) Explain the features of mortgage loans that are designed to reduce the likelihood of default.
3) What are points? What is their purpose?
4) How does an amortizing mortgage loan differ from a balloon mortgage loan?
5) Evaluate the advantages and disadvantages, from both the lender’s and the borrower’s
perspectives, of fixed–rate and adjustable–rate mortgages.
6) Why has the online lending market developed in recent years and what are the advantages
and disadvantages of this development?
7) Why may Fannie Mae and Freddie Mac pose a threat to the health of the financial system?
8) What are mortgage–backed securities, why were they developed, what types of mortgage–
backed securities are there, and how do they work?
9) What are the benefits and side effects of securitized mortgages?