Chapter 9—Mortgage Markets
1. Mortgage-backed securities are commonly contained within collateralized debt obligations.
a. True
b. False
2. Federally insured mortgages guarantee
a.
loan repayment to the lending financial institution.
b.
that the interest rate will not increase during the life of the mortgage.
c.
the lending financial institution a selling price for the mortgage in the secondary market.
d.
all of the above
3. At a given point in time, the interest rate offered on a new fixed-rate mortgage is typically ____ the
initial interest rate offered on a new adjustable-rate mortgage.
a.
below
b.
above
c.
equal to
d.
all of the above are very common
4. An institution that originates and holds a fixed-rate mortgage is adversely affected by ____ interest
rates; the borrower who was provided the mortgage is adversely affected by ____ interest rates.
a.
stable; decreasing
b.
increasing; stable
c.
increasing; decreasing
d.
decreasing; increasing
5. Rates for adjustable-rate mortgages are commonly tied to the
a.
average prime rate over the previous year.
b.
Fed’s discount rate over the previous year.
c.
average Treasury bill rate over the previous year.
d.
average Treasury bond rate over the previous year.
6. Caps on mortgage rate fluctuations with adjustable-rate mortgages (ARMs) are typically
a.
2 percent per year and 5 percent for the mortgage lifetime.
b.
5 percent per year and 15 percent for the mortgage lifetime.
c.
0 percent per year and 10 percent for the mortgage lifetime.
d.
3 percent per year and 8 percent for the mortgage lifetime.
7. From the perspective of the lending financial institution, interest rate risk is
a.
lower on a 30-year fixed-rate mortgage than on a 15-year fixed-rate mortgage.
b.
lower on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage.
c.
higher on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage.
d.
higher on a 15-year adjustable-rate mortgage than on a 30-year adjustable-rate mortgage.
8. Mortgage companies specialize in
a.
purchasing mortgages originated by other financial institutions.
b.
investing and maintaining mortgages that they create.
c.
originating mortgages and selling those mortgages.
d.
borrowing money through the creation of mortgages that is used to invest in real estate.
9. For any given interest rate, the shorter the life of the mortgage, the ____ the monthly payment and the
____ the total payments over the life of the mortgage.
a.
greater; greater
b.
greater; lower
c.
lower; greater
d.
lower; lower
10. A financial institution has a higher degree of interest rate risk on a ____ than a ____.
a.
30-year fixed-rate mortgage; 15-year fixed-rate mortgage
b.
30-year variable-rate mortgage; 30-year fixed-rate mortgage
c.
15-year fixed-rate mortgage; 30-year fixed-rate mortgage
d.
15-year variable-rate mortgage; 15-year fixed-rate mortgage
11. A balloon-payment mortgage requires interest payments for a 10– to 20-year period, at the end of
which the borrower must pay the full amount of the principal.
a. True
b. False
12. Use an amortization schedule. A 15-year $100,000 mortgage has a fixed mortgage rate of 9 percent. In
the first month, the total mortgage payment is $____, and $____ of this amount represents payment of
interest.
a.
1,014; 264
b.
1,241; 750
c.
1,014; 750
d.
none of the above
13. A mortgage that requires interest payments for a three- to five-year period, then full payment of
principal, is a(n)
a.
chattel mortgage.
b.
balloon payment mortgage.
c.
variable-rate mortgage.
d.
open-ended mortgage bond.
14. In an amortization schedule of monthly mortgage payments
a.
the amount of interest in each payment is equal to the principal paid.
b.
interest payments exceed principal payments early on.
c.
principal payments exceed interest payments early on.
d.
B and C both occur with about equal frequency
15. A mortgage with low initial payments that increase over time without ever leveling off is a
a.
graduated payment mortgage.
b.
growing-equity mortgage.
c.
second mortgage.
d.
shared-appreciation mortgage.
16. The interest rate on a second mortgage is ____ on a first mortgage created at the same time, because
the second mortgage is ____ the existing first mortgage in priority claim against the property in the
event of default.
a.
higher than; behind
b.
equal to that; equal to
c.
lower than; ahead of
d.
higher than; ahead of
e.
lower than; behind
17. Which of the following mortgages allows the home purchaser to obtain a mortgage at a below-market
interest rate throughout the life of the mortgage?
a.
second mortgage
b.
growing-equity mortgage
c.
graduated payment mortgage
d.
shared-appreciation mortgage
18. A ____ mortgage allows the borrower to initially make small payments on the mortgage. The
payments then increase over the first 5 to 10 years and then level off.
a.
graduated payment mortgage
b.
growing-equity mortgage
c.
second mortgage
d.
shared-appreciation mortgage
19. Mortgage companies, commercial banks and savings institutions are the primary originators of
mortgages.
a. True
b. False
20. ____ was created in 1968 as a corporation that is wholly owned by the federal government. It
guarantees payment on mortgages that meet specific criteria.
a.
Freddie Mac
b.
Ginnie Mae
c.
Fannie Mae
d.
None of the above
21. “Securitization” refers to the private insurance of conventional mortgages.
a. True
b. False
22. A financial institution may service a mortgage even after selling it.
a. True
b. False
23. The difference between the 30-year mortgages rate and the 30-year Treasury bond rate is primarily
attributable to
a.
interest rate risk.
b.
reinvestment rate risk.
c.
credit risk.
d.
insurance risk.
24. Mortgage prices would normally be expected to ____ when the interest rates ____, holding other
factors constant.
a.
increase; increase
b.
decrease; decrease
c.
increase; decrease
d.
none of the above
25. Collateralized mortgage obligations (CMOs) are generally perceived to have
a.
no prepayment risk but some default risk.
b.
no prepayment risk and no default risk.
c.
the same interest rate risk as money market securities.
d.
a high degree of prepayment risk.
26. Mortgage prices are subject to
a.
interest rate risk.
b.
credit risk.
c.
prepayment risk.
d.
all of the above.
27. During a weak economy, the credit risk to a financial institution from investing in mortgage-backed
securities representing subprime mortgages is ____ than that of mortgage-backed securities
representing prime mortgages.
a.
equal to
b.
slightly less than
c.
more than
d.
substantially less than
28. ____ are backed by conventional mortgages.
a.
Ginnie Mae mortgage-backed securities
b.
Federal Reserve mortgage-backed securities
c.
Private-label pass-through securities
d.
Shared appreciation pass-through securities
29. Which of the following is not a guarantor of federally insured mortgages?
a.
the Federal Housing Administration (FHA)
b.
the Veteran’s Administration (VA)
c.
the Federal Deposit Insurance Corporation (FDIC)
d.
all of the above are guarantors of federally insured mortgages
30. ____ economic growth will probably ____ the risk premium on mortgages and ____ the price of
mortgages.
a.
Strong; increase; decrease
b.
Strong; increase; increase
c.
Weak; decrease; increase
d.
Weak; increase; increase
e.
Weak; decrease; decrease
31. A ____ mortgage allows borrowers to initially make small payments on the mortgage, which are then
increased on a graduated basis over the first five to ten years; payments then level off from there on.
a.
balloon-payment
b.
graduated-payment
c.
shared-appreciation
d.
growing-equity
e.
none of the above
32. The adjustable-rate mortgage creates uncertainty for the ____ profit margin, but reduces the
uncertainty for the ____.
a.
originator’s; borrower
b.
borrower’s; originator
c.
government’s; originator
d.
none of the above
33. When financial institutions originate residential mortgages, the mortgage contract should not specify
a.
whether the mortgage is federally insured.
b.
the amount of the loan.
c.
whether the interest rate is fixed or adjustable.
d.
the maturity.
e.
the mortgage contract should specify all of the above
34. Which of the following is not a common type of mortgage-backed security according to your text?
a.
participation certificates (PCs)
b.
collateralized mortgage obligations (CMOs)
c.
balloon-payment mortgage certificates
d.
private-label pass-through securities
e.
all of the above are common types of mortgage pass-through securities
35. ____ risk is the risk that a borrower may prepay the mortgage in response to a decline in interest rates.
a.
Interest rate
b.
Credit
c.
Prepayment
d.
Reinvestment rate
36. Mortgage-backed securities are assigned ratings by:
a.
rating agencies.
b.
the Treasury.
c.
the Fed.
d.
the mortgage originator.
37. In a collateralized mortgage obligation (CMO), mortgages are segmented into ____ (or classes).
a.
balloon payments
b.
caps
c.
tranches
d.
strips
38. The credit crisis is mostly attributed to the use of:
a.
strict criteria applied by mortgage originators.
b.
liberal criteria applied by mortgage originators.
c.
very tough credit ratings applied to mortgages.
d.
fixed-rate mortgages with long terms to maturity.
39. Fannie Mae and Freddie Mac experienced financial problems during the credit crisis because they:
a.
were unwilling to finance new mortgages.
b.
invested heavily in balloon mortgages.
c.
invested only in prime mortgages that offered very low returns.
d.
invested heavily in subprime mortgages.
40. ____ mortgages enabled more people with relatively lower income, or high existing debt, or a small
down payment to purchase homes.
a.
Prime
b.
Balloon
c.
Amortized
d.
Subprime
41. The secondary mortgage market that accommodates originators of mortgages who desire to sell their
mortgages before maturity.
a. True
b. False
42. Regardless of what happens to market interest rates, most adjustable-rate mortgages (ARMs) specify a
maximum allowable fluctuation in the mortgage rate per year and over the mortgage life.
a. True
b. False
43. Some adjustable-rate mortgages (ARMs) contain an option clause that allows mortgage holders to
switch to a fixed-rate mortgage within a specified period.
a. True
b. False
44. Mortgage lenders normally charge a higher initial interest rate on adjustable-rate mortgages than on
fixed-rate mortgages.
a. True
b. False
45. A balloon-payment mortgage requires interest payments for a three- to five-year period. At the end of
this period, full payment of the principal (the balloon payment) is required.
a. True
b. False
46. During the early years of a mortgage, most of the monthly payment reflects principal.
a. True
b. False
47. Mortgages are rarely sold in the secondary market.
a. True
b. False
48. An increase in either the risk-free rate or the risk premium on a fixed-rate mortgage results in a higher
required rate of return when investing in the mortgage and therefore causes mortgage prices to
decrease.
a. True
b. False
49. Strong economic growth tends to reduce the probability that the issuer of a mortgage will default on its
debt payments and therefore tends to decrease mortgage prices.
a. True
b. False
50. The higher the level of equity invested by the borrower, the higher the probability that the loan will
default.
a. True
b. False
51. Borrowers who have a lower level of income relative to the periodic loan payments are more likely to
default on their mortgages.
a. True
b. False
52. Non-U.S. financial institutions never hold mortgages on U.S. property.
a. True
b. False
53. The ____ market accommodates originators of mortgages that desire to sell their mortgages prior to
maturity.
a.
primary
b.
secondary
c.
money
d.
none of the above
54. Financial institutions that hold fixed-rate mortgages in their asset portfolios are exposed to ____ risk,
because they commonly use funds obtained from short-term customer deposits to make long-term
mortgage loans.
a.
exchange rate
b.
prepayment
c.
reinvestment rate
d.
interest rate
e.
exchange rate
55. From the perspective of the lending financial institution, there is a ____ degree of interest rate risk for
____-maturity mortgages.
a.
higher; shorter
b.
higher; longer
c.
lower; shorter
d.
lower; higher
e.
Answers B and C are correct.
56. During the early years of a mortgage,
a.
most of the monthly payment reflects principal reduction.
b.
most of the monthly payment reflects interest.
c.
about half of the monthly payment reflects interest.
d.
Cannot answer without more information.
57. Which of the following will typically require homeowners to ultimately request a new mortgage?
a.
graduated-payment mortgage (GPM)
b.
growing-equity mortgage
c.
balloon-payment mortgage
d.
shared-appreciation mortgage
58. Which of the following is not true with respect to a growing-equity mortgage?
a.
It is similar to a graduated-payment mortgage.
b.
It allows borrowers to initially make small payments on the mortgage.
c.
It involves increased payments, on a graduated basis, over the first five to ten years of the
mortgage.
d.
It involves payments that level off after the first five to ten years of the mortgage.
59. ____ economic growth will probably ____ the risk premium on mortgages and ____ the price of
mortgages.
a.
Strong; decrease; decrease
b.
Strong; increase; increase
c.
Weak; increase; increase
d.
Weak; decrease; increase
e.
Weak; decrease; decrease
60. The probability that a borrower will default (credit risk) is influenced by all of the following, except
a.
economic conditions.
b.
the level of equity invested by the borrower.
c.
the borrower’s income level.
d.
the borrower’s credit history.
e.
Credit risk is affected by all of the above.
61. In a short sale of a home:
a.
the lender forecloses and then sells the home for less than what is owed on the mortgage.
b.
the lender allows the homeowner to sell the home for less than what is owed on the
mortgage.
c.
the lender does not recover the full amount of the mortgage.
d.
B and C
e.
A and C
62. An investor in interest-only collateralized mortgage obligations (CMOs) would not be concerned that
homeowners will prepay the underlying mortgages.
a. True
b. False
63. The valuation of mortgage-backed securities is difficult because of limited
transparency.
a. True
b. False
64. A(n) _________ problem occurs when a person or institution does not have to bear the full
consequence of its behavior and therefore assumes more risk than it otherwise would.
a.
asymmetric information
b.
moral hazard
c.
risk adjustment
d.
specific hazard
65. A __________ is a privately negotiated contract that protects investors against the risk of default on
particular debt securities such as mortgage-backed securities.
a.
default insurance contract
b.
default risk swap
c.
credit default swap
d.
collateralized debt obligation
66. Speculators sell credit default swaps to benefit from the default of specific subprime mortgages.
a. True
b. False