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FIN 502 : CHAPTER 13 buying a home and mortgage financing.docx

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beigefish258
21 Apr 2012
School
Ryerson University
Department
Finance
Course
FIN 502
Professor
Steve Joyce

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Document Summary

Chapter 13 buying a home and mortgage financing. Mortgage financing: traditional way of borrowing money to purchase a home. Home mortgage: real estate loan with equal monthly payments. First mortgage: mortgage where the conveyance of title. Second mortgage: the right to a further equity of redemption which can again be mortgaged. Basic concepts and terminology: principle: amount of money that is being borrowed, amortization: gradual retirement of a debt by means of partial payments of the principal at. In canada, mortgage rates are stated as an annual rate with semi-annual compounding but the loan is normally repaid by monthly payments: compounding period (6 months) is different from repayment period (1 month) Outstanding principle (outstanding balance): equal to the present value of the remaining stream of payments, discounted at the equivalent monthly compounding rate. Canadian financial institutions will not lend more than 75% of the appraised value of the house; to buy a house, need a down payment of 25%

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Related Questions

You would like to buy a home. Unfortunately, you have no cash to pay the whole price of the house. So, you are taking mortgage to finance the purchase. Now you are shopping for the best mortgage. A. What financial model you will use in order to estimate the mortgage you can take? B. List three necessary values you have to know in order to compute the value of the mortgage. C. What assumptions you are making when you are computing the mortgage payments?

You would like to buy a home. Unfortunately, you have no cash to pay the whole price of the house. So, you are taking mortgage to finance the purchase. Now you are shopping for the best mortgage for you.

A. What financial model you will use in order to estimate the mortgage you can take?

B. List three necessary values you have to know in order to compute the value of the mortgage.

C. What assumptions you are making when you are computing the mortgage payments?

Mortgage markets have developed significantly since the early 1970s through the creation of secondary market instruments in the form of mortgage pass-throughs, collateralized mortgage obligations (CMOs), and REMICs. These collectively have been generally referred to as mortgage backed securities (MBS). In many ways, these instruments carry the characteristics of their underlying assets -- individual mortgages.

a. Why is the cash flow of a mortgage, or a MBS, uncertain in the sense that the investor in the mortgage has granted the borrower a call option to prepay the mortgage? Compare a mortgage cash flow with a Treasury coupon bearing bond paying interest semi-annually and a payment of principal at maturity.

b. What does this call option depend upon and why?

c. The cash flow for a mortgage pass-through typically is based on some prepayment speed benchmark. Why is the assumed prepayment speed necessary to price the MBS?

d. Suppose a bank has decided to invest in a MBS and is considering the following two securities: a Freddie Mac pass-through with a WAM of 340 months and an average life of 7 years or a PAC tranche of a Freddie Mac CMO issue with an average life of 2 years. In terms of prepayment risk, contraction risk and extension risk, which MBS would probably be best for the bank’s asset/liability management perspective when it is known that liabilities generally have a duration less than 1 year and that assets have durations in the 2-year to 7-year range?