ARM lender discussion paper

Homework 3 Name:
 
1. What is the meaning of the following: Interest is capped at 2%/5%.
A. The loan has a 2% annual cap rate and a 5% lifetime cap rate.
B. The borrower can choose the cap he wants by simply circling the appropriate choice.
C. The loan has a 2% lifetime cap rate and a 5% annual cap rate.
D. The loan has a 2% annual cap rate and a 5% floor cap rate.
 
2. Which of the following descriptions most accurately reflects the risk position of an ARM lender in comparison to that of a FRM lender?

 
Interest Rate Risk
Default Risk

(A)
Higher
Higher

(B)
Lower
Lower

(C)
Higher
Lower

 
Lower
Higher

A. Option A
B. Option B
C. Option C
D. Option D
 
3. Which is NOT a component of an ARM?
A. A margin
B. An index
C. A chapter
D. Caps
 
4. A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a “teaser” rate of 4%, after that, the rate can reset with a 5% annual payment cap. On the reset date, the composite rate is 6%. Assume that the loan allows for negative amortization. What would be the outstanding balance on the loan at the end of Year 3?
A. $190,074
B. $192,337
C. $192,812
D.$192,926