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Indicate whether the statement is true or false.
1. A financial institution may service a mortgage even after selling it.
a. True
b. False
2. 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
3. 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
4. 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
5. The higher the level of equity invested by the borrower, the higher the probability that the loan will default.
a. True
b. False
6. An investor in interest-only collateralized mortgage obligations (CMOs) would not be concerned that homeowners will
prepay the underlying mortgages.
a. True
b. False
7. Non-U.S. financial institutions never hold mortgages on U.S. property.
a. True
b. False
8. Mortgage companies, commercial banks, and savings institutions are the primary originators of mortgages.
a. True
b. False
9. The valuation of mortgage-backed securities is difficult because of limited transparency.
a. True
b. False
10. Speculators sell credit default swaps to benefit from the default of specific subprime mortgages.
a. True
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11. Mortgage lenders normally charge a higher initial interest rate on adjustable-rate mortgages than on fixed-rate
mortgages.
a. True
b. False
12. 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 the mortgage price to decrease.
a. True
b. False
13. Strong economic growth tends to reduce the probability that borrowers will default on their mortgage payments and
therefore tends to decrease mortgage prices.
a. True
b. False
14. During the early years of a mortgage, most of the monthly payment reflects principal.
a. True
b. False
15. Mortgages are rarely sold in the secondary market.
a. True
b. False
16. Mortgage-backed securities are commonly contained within collateralized debt obligations.
a. True
b. False
17. Financial institutions may purchase credit default swaps on mortgages if they expect defaults on many mortgages.
a. True
b. False
18. The secondary mortgage market accommodates originators of mortgages who desire to sell their mortgages before
maturity.
a. True
b. False
19. Borrowers who have a lower level of income relative to their periodic loan payments are more likely to default on
their mortgages.
a. True
b. False
20. Financial institutions may sell credit default swaps on mortgages if they expect defaults on many mortgages.
a. True
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b. False
21. “Securitization” refers to the private insurance of conventional mortgages.
a. True
b. False
22. A balloon-payment mortgage requires only 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
Indicate the answer choice that best completes the statement or answers the question.
23. ____ 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
24. A mortgage contract specifies
a. the interest rate.
b. the collateral backing the loan.
c. whether the interest rate is fixed or adjustable.
d. the maturity.
e. all of the above.
25. A(n) _________ problem occurs when a person or institution does not have to bear the full consequences of its
behavior and therefore assumes more risk than it otherwise would.
a. asymmetric information
b. moral hazard
c. risk adjustment
d. specific hazard
26. 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.
27. 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 these are very common.
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28. The ____ market accommodates originators of mortgages that desire to sell their mortgages prior to maturity.
a. primary
b. secondary
c. money
d. None of these are correct.
29. 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 debt-to-income level.
d. the borrower’s credit score.
e. Credit risk is affected by all of these.
30. Which of the following will typically require the borrower to ultimately request a new mortgage?
a. graduated-payment mortgage (GPM)
b. growing-equity mortgage
c. balloon-payment mortgage
d. shared-appreciation mortgage
31. 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 these are correct.
32. ____ mortgages enable 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
33. 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. the lender allows the homeowner to sell the home for less than what is owed on the mortgage AND the lender
does not recover the full amount of the mortgage.
e. the lender forecloses and then sells the home for less than what is owed on the mortgage AND the lender does not
recover the full amount of the mortgage.
34. 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
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e. exchange rate
35. 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-payment mortgages.
c. invested only in prime mortgages that offered very low returns.
d. invested heavily in subprime mortgages.
36. In the earlier 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. all of the monthly payment reflects principal reduction.
37. The difference between the 30-year mortgage 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.
38. Which of the following is NOT a common type of mortgage-backed security according to your text?
a. FHLMA (Freddie Mac) participation certificates (PCs)
b. collateralized mortgage obligations (CMOs)
c. balloon-payment mortgage certificates
d. private-label pass-through securities
e. All of these are common types of mortgage pass-through securities.
39. Mortgage-backed securities are assigned ratings by
a. rating agencies.
b. the U.S. Treasury
c. the Federal Reserve.
d. the mortgage originator.
40. 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
41. ___ economic growth will probably ____ the risk premium on mortgages and cause the price of mortgages in the
secondary market to _____.
a. Strong; increase; decrease
b. Strong; increase; increase
c. Weak; increase; decrease
d. Weak; increase; increase
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e. Weak; decrease; decrease
42. ____ was created in 1968 as a corporation that is wholly owned by the federal government. It guarantees payment on
FHA and VA mortgages that meet specific criteria.
a. Freddie Mac
b. Ginnie Mae
c. Fannie Mae
d. None of these are correct.
43. The interest rate on a second mortgage is ____ the rate 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
44. 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
45. 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
46. 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.
47. Which of the following was part of the U.S. government’s response to the credit crisis?
a. Troubled Asset Relief Program (TARP)
b. Housing and Economic Recovery Act
c. Homeowners’ Mortgage Guarantee Act
d. Troubled Asset Relief Program (TARP) AND Housing and Economic Recovery Act
48. 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
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c. 15-year fixed-rate mortgage; 30-year fixed-rate mortgage
d. 15-year variable-rate mortgage; 15-year fixed-rate mortgage
49. An adjustable-rate mortgage increases interest rate risk for the ____, but reduces interest rate risk for the ____.
a. originator; borrower
b. borrower; originator
c. government; originator
d. None of these are correct.
50. Which of the following are important criteria that financial institutions consider when assessing the creditworthiness
of a prospective borrower for a mortgage?
a. the down payment the borrower will make
b. the borrower’s debt-to-income ratio
c. the borrower’s credit score
d. all of the above
51. 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
52. At a given point in time, the price of a credit default swap contract should be ________ related to the default risk of
the securities covered by the contract. For a given set of securities that are covered by a credit default swap, the price of
the contract should be _______ related to the default risk as it changes over time.
a. positively; positively
b. positively; inversely
c. Inversely; positively
d. inversely; inversely
53. 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.
54. Which of the following was a major contributor to the credit crisis?
a. strict criteria applied by mortgage originators
b. liberal criteria applied by mortgage originators
c. very strict credit ratings applied to mortgage-backed securities
d. fixed-rate mortgages with long terms to maturity
55. Mortgage companies specialize in
a. purchasing mortgages originated by other financial institutions.
b. investing and maintaining mortgages that they create.
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c. originating mortgages and selling those mortgages.
d. borrowing money through the creation of mortgages that is used to invest in real estate.
56. Which of the following is NOT true with respect to a growing-equity mortgage?
a. It is similar to a graduated-payment mortgage.
b. The monthly payments on the mortgage are initially small.
c. The monthly payments increase throughout the life of the mortgage.
d. The monthly payments increase for the first 5 to 10 years of the mortgage and then level off.
57. Which of the following is NOT a guarantor of federally insured mortgages?
a. Federal Housing Administration (FHA)
b. Veterans Administration (VA)
c. Federal Deposit Insurance Corporation (FDIC)
d. All of these are guarantors of federally insured mortgages.
58. 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.
59. 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
60. American International Group (AIG) was a huge _______ of credit default swaps (CDS) that offered protection
against mortgage defaults, so when many mortgages defaulted during the credit crisis, AIG was obliged to _______.
a. seller; repurchase the CDS contracts it had sold
b. buyer; sell its CDS contracts to raise capital
c. buyer; surrender its CDS contracts to the Federal Reserve
d. seller; make large payments to the buyers of the CDS contracts
61. Bear Stearns commonly used __________ as collateral when borrowing short-term funds, but its funding was cut off
because prospective creditors questioned the quality of the collateral.
a. commercial paper
b. Treasury securities
c. its stock
d. mortgages
62. In a collateralized mortgage obligation (CMO), mortgages are segmented into ____ (or classes).
a. balloon payments
b. caps
c. tranches
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d. strips
63. 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.
64. 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. higher; longer AND lower; shorter
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Answer Key
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