CHAPTER 25 CASE C-1
CHAPTER 25
WILLIAMSON MORTGAGE, INC.
1. Jerry’s mortgage payments form a 25-year annuity with monthly payments, discounted at the long-
term interest rate of 5.5 percent. We can solve for the payment amount so that the present value of
2. The most significant risk that she faces is interest rate risk. If the current market rate of interest rises
between today and the date the mortgage is sold, the fair value of the mortgage will decrease, and
3. Treasury bond prices have an inverse relationship with interest rates. As interest rates rise, Treasury
bonds become less valuable; as interest rates fall, Treasury bonds become more valuable. Since
Jennifer will be hurt when interest rates rise, she is also hurt when Treasury bonds decrease in value.
In order to protect herself from decreases in the price of Treasury bonds, she should take a short
4. a. If the market interest rate is 6.2 percent on the date that Jennifer meets with the Max, the fair
value of the mortgage is the present value of an annuity that makes monthly payments of
b. An increase in the interest rate will cause the value of the T-bond futures contracts to decrease.
5. a. If the market interest rate is 4.6 percent on the date that Jennifer meets with Max, the fair value of
the mortgage is the present value of an annuity that makes monthly payments of $3,070.44 for
CHAPTER 25 CASE C-2
b. An increase in the interest rate will cause the value of the Treasury bond futures contracts to
6. The biggest risk is that the hedge is not a perfect hedge. If interest rates change, the fact that
Treasury bond interest is semiannual, while the mortgage payments are monthly, may affect the
relative value of the two. Additionally, while a change in one of the interest rates will likely coincide
with a change in the other interest rate, the change does not have to be the same. For example, the