FIN 331 Exam 2
Federally Insured Mortgages: A) Both the mortgage and the borrower must meet the requirements of the FHA or VA; B) The loan repayment of mortgages is guaranteed by the Federal Housing Administration (FHA) or Veteran Administration (VA); C) FHA and VA mortgages usually have very low or zero down payment requirement. D) All the above.
Answer: D) All the above.
Stock Markets: A) Stock markets facilitate the transfer of funds for stocks in the primary market and the exchange of the ownership in the secondary market. B) The primary market facilitates new financing for corporations; C) The secondary market provides liquidity for investors who own the stocks. D) Typically the pricing information comes from the stock market (supply and demand). E) All of the above.
Answer: E) All of the above.
Floors and Caps for Adjustable Rate Mortgages: A) Most ARMs specify both periodic caps and lifetime rate caps and floors (i.e., a maximum allowable adjustment in the mortgage rate per year and over the mortgage life.) B) The rates are commonly 3 to 5 percent per year and 7 to 8 percent for the mortgage lifetime. C) Caps are meant to be a protection to the borrowers. D) Floors are supposed to provide a minimum rate for the lenders. With the caps, lenders take some interest rate risk. E) All of the above. F) A, C, & D
Answer: F) A, C & D The rates are commonly 1 to 2 percent per year and 5 to 6 percent for the mortgage lifetime
What type of mortgages can reduce default risk and prepayment and interest rate risk?
Mortgage designs similar to Adjustable Rate Mortgages
PRESENTATION QUESTION: Know that overconfident investors will overestimate the value of their private information
Overconfident investors will overestimate the value of their private information.
Tilt Problem for Fixed Rate Mortgage Borrowers: Due to the impact of inflation, the real value of the level mortgage payments will decline over time. Inflation + (increase), Real Value of Level Mortgage Payments - (decrease). In addition, the income of homeowners usually increases over time relative to the level of mortgage payments. How does this effect borrowers and what is the impact?
The real burden of mortgage payments is tilted toward the early years of the mortgage life. (It is more expensive to own a home in the beginning). Such a tilt problem discourages potential homeowners buying a home in their early earning years. These problems lead to the development of new mortgage products, such as the adjustable-rate mortgage.
Other Mortgage Designs: What is Graduated-Payment Mortgage (GPM)? Why was it created? Can it negatively amortize?
The tilt problem leads to the development of GPMs. Initial payments are low and increase gradually over the first 5 to 10 years; then payments level off thereafter. The GPMs are designed to make home ownership more affordable for people who expect their income to rise over time (most people). A graduated payment mortgage can also negatively amortize depending on how high the interest rate is
when interest rates fall, could the owners/investors of the mortgages continue receiving the high interest rates on the old mortgages?
Think of callable bonds. People could be stuck paying the higher rates, or they could refinance. They might also want to sell and buy a new home at a lower rate. This hurts the lender. https://www.investopedia.com/terms/p/prepaymentrisk.asp
True or False: With Adjustable-Rate Mortgages, the borrower bears the interest rate risk.
True! With Adjustable-Rate Mortgages, the borrower bears the interest rate risk. The default risk of ARM may increase as interest rates rise. With the caps, lenders take some interest rate risk.
Who bears the cost of the protection offered by caps built in the ARM contract?
With the caps, lenders take some interest rate risk
What are the five types of mortgages?
1) Fixed-rate mortgage 2) Adjustable-rate mortgage (Option ARM, and interest-only ARM) 3) Federally Insured mortgage 4) Conventional mortgages 5) Other creative mortgage designs (GPM, GEM, SAM, etc)
How does a dealer/principal earn profit?
A dealer/principal earns profit from the bid-ask spread. Dealers are executing trades for themselves and making money on the bid-ask spread. This involves buying a security and then selling it at a higher price. Aka markup.
What is a principal also known as?
A principal is also known as a dealer. A dealer is an individual or financial services company that enables the trading of securities for themselves.
Other Mortgage Designs: What do Balloon Payment mortgage, Rollover Mortgage (ROM), and Renegotiated-Rate Mortgage (RRM) have in common?
All of them provide borrowers a fixed-rate mortgage that expires at a predetermined time (often 3 to 7 years). The unpaid balance of the mortgages comes due in a large balloon payment, which *can* be refinanced at the prevailing market interest rates. Balloon payment mortgages are risky for borrowers because their refinancing at maturity is not guaranteed. ROMs and RRMs reduce the risk associated with the balloon payment mortgages by guaranteeing that the unpaid balance can be refinanced at the prevailing interest rates.
What is an agent also known as?
An agent is also known as a broker. A broker is an individual or financial services company that enables the trading of securities for other individuals.
How does an agent/broker earn profit?
An agent/broker earns profit primarily via brokerage fees. Brokerage fees are charged for executing a trade. A broker will charge either a flat fee per transaction or will charge a fee based on a percentage of sales.
Select the ones that are correct. Securitization brings many benefits to FIs and allows FIs to: 1) become more liquid. 2) reduce interest rate and credit risk. 3) reduce capital and reserve requirements. 4) generate fee income from servicing more mortgages than they could otherwise.
Answer) All are correct. *This applies to all types of securities. This is most commonly used with mortgage backed securities.* Allows FIs to: 1) become more liquid, 2) reduce interest rate and credit risk, 3) reduce capital and reserve requirements, and 4) generate fee income from servicing more mortgages than they could otherwise.
You purchase a $180,000 house and you pay 20% down. The interest rate is a 9% APR for 360 monthly payments. What is the monthly payment? A) $1,159 B) $1,448 C) $1,363 D) $1,072 E) $998
Answer: A) $1,159
National Association of Securities Dealers Automatic Quotations system (NASDAQ) is a major development in the OTC markets. It currently has over _____ stocks traded on the NASDAQ. A) 5,000 B) 6,000 C) 8,000 D) 10,000
Answer: A) 5,000 Currently, over 5000 stocks are traded on the NASDAQ. It provides continuous bid and ask prices for actively traded OTC stocks. It accelerates the disclosure of price quotations from dealers to brokers. NASDAQ also has some listing requirements. Currently, over 5000 stocks are traded on the NASDAQ. Although more stocks are traded on the NASDAQ than on the NYSE, the total market capitalization ($1.5 trillion in 1996) is much smaller (less than one fourth).
You have $10,000 to invest in a mutual fund with a NAV = $50. You choose a fund with a 5% front-end load and a 1% management fee. The management fee is imposed on year end assets. The gross annual return on the fund's shares was 15%. What was your net annual rate of return to the nearest basis point? A) 8.16% B) 9.00% C) 8.50% D) 8.44% E) 7.75%
Answer: A) 8.16%
When an underwriter engages in a firm commitment, the underwriter is acting as A) A principal B) An agent C) An asset transformer D) An M&A advisor E) All of the above
Answer: A) A principal When an underwriter engages in a firm commitment, the underwriter is acting as a principal (aka dealer). In a firm commitment, an underwriter acts as a dealer and assumes responsibility for any unsold inventory. For taking on this risk through a firm commitment, the dealer profits from a negotiated spread between the purchase price from the issuer and the public offering price to the public. A firm underwriting is also known as a principal or dealer transaction. When a customer is sold a security from the inventory of a financial firm, a principal (dealer) transaction occurred. With a firm underwriting, the investment bank sells a security that they own and is considered its inventory. The firm makes money if they buy the security at a low price and re-sell it at a marked-up price.
When acting as a broker: A) the firm is an agent; B) the firm does not assume risk; C) the firm earns a commission; D) All the above E) A & C
Answer: A) All of the above. When acting as a broker, the firm is an agent that does not assume risk and earns a comission.
When acting as a dealer: A) the firm is a principal; B) the firm does assume risk; C) the firm earns a markup or markdown; D) All the above E) B & C
Answer: A) All of the above. When acting as a dealer, the firm is a principal that does assume risk and earns a markup or markdown.
Who does the risk of the balloon payments mortgages fall on? A) The borrowers. B) The lenders. C) It is evenly split. D) Not enough information.
Answer: A) Balloon payment mortgages are risky for borrowers because their refinancing at maturity is not guaranteed. ROMs and RRMs reduce the risk associated with the balloon payment mortgages by guaranteeing that the unpaid balance can be refinanced at the prevailing interest rates.
Market Order: A) buy or sell immediately at the current market price. B) an order to buy at or below a specified price or to sell at or above a specified price. C) becomes a market order to sell a stock when its market price reaches or drops below a specified level. D) becomes a market order to buy a stock when its market price reaches or rises above a specified level. E) becomes a limit order when the stop price is reached.
Answer: A) buy or sell immediately at the current market price. Market Order: buy or sell immediately at the current market price. the simplest and fastest way to complete a trade. market orders are usually executed as soon as the orders reach the exchange floor or are received by the dealer.
In general, default risk of mortgages is relatively low due to: A) the presence of collateral B) underwriting standards C) federal guarantees or private mortgage insurance D) low credits scores E) A, B, & C
Answer: A, B, & C In general, default risk of mortgages is relatively low due to: 1. the presence of collateral, 2. underwriting standards, and 3. federal guarantees or private mortgage insurance. low credit scores increase default risk.
An open end mutual fund owns 1000 share of Krispy Kreme priced at $50. The fund also owns 2000 shares of Ben & Jerry's priced at $75, and 1000 shares of Pepsi priced at $65. The fund itself has 2000 of its own shares outstanding. What is the NAV of a fund's share? A) $140.25 B) $132.50 C) $265.00 D) $242.00 E) $175.55
Answer: B) $132.50 Net Asset Value (NAV) of Mutual Fund Shares NAV = Net assets of the fund divided by the number of mutual fund shares outstanding where - Net assets of the fund equals the total assets minus total liabilities. - Total assets of the fund include market value of securities holdings plus cash and receivables. - Total liabilities contain payables and accrued expenses.
How much is one discount point worth? A) 0.5% of the loan. B) 1% of the loan. C) 0.01% of the loan. D) None of the above. Bonus questions: How do you calculate if it is worth paying the points? Does this account for the time value of money?
Answer: B) 1% of the loan. One discount point is 1% of the loan amount. A breakeven analysis is used to find if it is worth paying the points. Equation: the dollar value of the points / monthly payment savings = number of months required to recoup the points If the borrower expects to live in the house for the breakeven number of months or longer, it is worthwhile to pay the points. This does not account for the time value of money.
Lisa Yang recently purchased YAHOO stock with a 60 percent margin. This information indicates that A) Ms. Yang cannot lose more than 40 percent of the money she has invested. B) 60 percent of the investment was financed with Ms. Yang's own capital, and 40 percent was financed with borrowed money. C) 40 percent of the investment was financed with Yang's own capital, and 60 percent was financed with borrowed money. D) Ms. Yang cannot lose more than 60 percent of the money she has invested.
Answer: B) 60 percent of the investment was financed with Ms. Yang's own capital, and 40 percent was financed with borrowed money. Margin refers to the amount of equity an investor has in their brokerage account. In this case, Ms. Yang is the investor.
The American Stock Exchange (AMEX), (the second major national exchange market, specifically an auction market since it does stock exchanges) has about _____ companies. A) 900 B) 800 C) 1,000 D) 1,200
Answer: B) 800. AMEX has about 800 companies.
What is the difference between a Pass Through Security and a Collateralized Mortgage Obligation (CMO)? A) A Pass Through Security is a Mortgage Backed Security, a Collateralized Mortgage Obligation is not. B) CMOs alter the distribution of interest and principal from a pro rata distribution (for pass-throughs) to an unequal (typically sequential) distribution. C) Collateralized mortgage obligations allow interested investors to financially benefit from the mortgage industry without having to buy or sell a home loan. D) B & C.
Answer: B) CMOs alter the distribution of interest and principal from a pro rata distribution (for pass-throughs) to an unequal (typically sequential) distribution Collateralized mortgage obligations AND mortgage-backed securities allow interested investors to financially benefit from the mortgage industry without having to buy or sell a home loan. A CMO is a type of MBS, but CMOs are different because they are broken up into tranches, and the way the investors who own them get paid is different than with a traditional MBS. A collateralized mortgage obligation, or CMO, is a type of MBS in which mortgages are bundled together and sold as one investment, ordered by maturity and level of risk. A mortgage-backed security, or an MBS, is a kind of asset-backed security that represents the amount of interest in a pool of mortgage loans.
______ Stocks are traded on the NASDAQ than on the NYSE. The total market capitalization of the NASDAQ is much ________ than the NYSE. A) More, Bigger B) More, Smaller C) Less, Bigger D) Less, Smaller
Answer: B) More, Smaller Currently, over 5000 stocks are traded on the NASDAQ. Although more stocks are traded on the NASDAQ than on the NYSE, the total market capitalization ($1.5 trillion in 1996) is much smaller (less than one fourth).
What is the relationship between default risk and interest rates with adjustable-rate mortgages (ARMs)? A) There is an inverse relationship. (As interest rates decrease, default risk increases.) B) There is a positive relationship. (As interest rates increase, default risk increases.)
Answer: B) There is a positive relationship. The default risk of ARM may increase as interest rates rise. The borrower bears the interest rate risk in ARM. If interest rates go up, and their payments rise to match the market interest rates, they may not be able to afford the payments anymore.
Limit Order: A) buy or sell immediately at the current market price. B) an order to buy at or below a specified price or to sell at or above a specified price. C) becomes a market order to sell a stock when its market price reaches or drops below a specified level. D) becomes a market order to buy a stock when its market price reaches or rises above a specified level. E) becomes a limit order when the stop price is reached.
Answer: B) an order to buy at or below a specified price or to sell at or above a specified price. Limit Order: an order to buy at or below a specified price or to sell at or above a specified price A limit order is a conditional order, which is not guaranteed to be executed. In general, limit orders are very effective when the price of a stock fluctuate greatly and frequently
The price of a share in a closed-end fund is A) equal to the net asset value per share. B) determined by supply and demand in a market. C) suggested by Morningstar, Inc. D) set by the investment company that manages the fund
Answer: B) determined by supply and demand in a market. The price of a share in a closed-end fund is determined by supply and demand in a market. A closed-end fund is a type of mutual fund that issues a fixed number of shares through a single initial public offering (IPO) to raise capital for its initial investments. Its shares can then be bought and sold on a stock exchange but no new shares will be created and no new money will flow into the fund. Shares of a closed-end fund trade throughout the day on a stock exchange, and that market-driven price may differ from its NAV.
Assume Indi Jones sells short 90 shares of XYZ stock at $31.25 per share and six months later purchases the shares at $29.00 each. Ignoring brokerage fees, Indi would A) earn a total profit of $2,181.50. B) earn a total profit of $202.50. C) lose a total of $225.00. D) lose a total of $202.50.
Answer: B) earn a total profit of $202.50.
If wages are increasing throughout a worker's lifetime which one of the following defined benefit formulas would probably be best for the employee? A. Flat benefit B. Final pay C. Career average D. Either A or C but not B
Answer: B. If wages are increasing throughout a worker's lifetime FINAL PAY defined benefit formula would probably be best for the employee. −Final pay formula - pays benefits based on certain percentage (benefit factor) of the average salary during final working years times the number of years of service. If wages were NOT increasing throughout a worker's lifetime, these options would be viable: −Flat benefit formula - pays a flat amount for every year of employment; for example, $1600 per year of service. −Career average formula - pays benefits based on the average salary over the entire period of employment.
A defined benefit pension plan has expected payouts of $15 million per year over the next 30 years. The fund can be expected to earn an average of 8% on its assets. It currently has reserves of $135 million. The fund is A. Fully funded B. Underfunded C. Overfunded D. Bankrupt E. In violation of ERISA
Answer: B. Underfunded
A borrower takes out a 30 year fixed rate mortgage of $100,000 at a 9% APR. In five years, he wishes to pay off the remaining balance. Interest rates have fallen to 7%. How much must he pay? A) $89,775 B) $95,609 C) $95,880 D) $91,638 E) $51,723
Answer: C) $95,880
Carlita Rosarita bought $6,500 worth of stock with an initial margin of 60 percent. She held the stock for a year, during which time interest costs on her margin account were $200, then she sold the stock for $7,500. What was Carlita's return on equity (i.e., return on her own invested capital)? A) 40.8% B) 30.8% C) 20.5% D) 25.6%
Answer: C) 20.5%
Other Mortgage Designs: Shared-Appreciation Mortgage (SAM) What price can a home buyer obtain a mortgage at with a SAM? A) At Market Rate. B) Above-Market Rate. C) Below-Market Rate.
Answer: C) Below Market Rate With a SAM, a home buyer can obtain a mortgage at a below-market rate. In return, the lender will share in the price appreciation of the home. How the price appreciation is shared between two parties is subject to negotiation.
. Open-end mutual funds guarantee A) Investors a minimum rate of return B) Investors a minimum NAV C) To redeem investor's shares upon demand at current NAV D) To earn the rate promised in the prospectus E) None of the above
Answer: C) To redeem investor's shares upon demand at current NAV Open-end mutual funds guarantee to redeem investor's shares upon demand at current NAV (net asset value). An open-end fund is a diversified portfolio of pooled investor money that can issue an unlimited number of shares. The fund sponsor sells shares directly to investors and redeems them as well. These shares are priced daily based on their current net asset value (NAV). Some mutual funds, hedge funds, and exchange-traded funds (ETFs) are types of open-end funds. Open-end shares do not trade on exchanges and are priced at their portfolio's net asset value (NAV) at the end of each day.
A Sell Stop Order: A) buy or sell immediately at the current market price. B) an order to buy at or below a specified price or to sell at or above a specified price. C) becomes a market order to sell a stock when its market price reaches or drops below a specified level. D) becomes a market order to buy a stock when its market price reaches or rises above a specified level. E) becomes a limit order when the stop price is reached.
Answer: C) becomes a market order to sell a stock when its market price reaches or drops below a specified level. A sell stop order becomes a market order to sell a stock when its market price reaches or drops below a specified level. made to protect investors against a rapid decline in stock price.
The largest asset category of life insurers is _____ and the largest liability category is _____. A. Bonds; separate account business B. Separate account items; current policy claims C. Bonds; net policy reserves D. Policy reserves; mortgage loans E. Separate account business; net policy reserves
Answer: C. Bonds; net policy reserves The largest asset category of life insurers is bonds and the largest liability category is net policy reserves. Assets: Corporate bonds (40.4% of total assets). Liabilities: Net policy reserves (47.8% of total liabilities) - estimated PV of expected future payment on existing policy contracts.
Suppose that a mutual fund has two million shares outstanding. Its portfolio includes one million shares of Costco priced at $42, one million shares of Qualcomm priced at $38, one million shares of Yahoo priced at $15, and one million shares of Cisco priced at $15. This fund also has liabilities of 4 million dollars. The net asset value per share is A) $110. B) $106. C) $55. D) $53. E) impossible to calculate unless we have information on whether the mutual fund is a load fund or a no-load fund.
Answer: D) $53. NAV is the total market value of security holdings (less any liabilities) divided by the number of outstanding fund shares.
The New York Stock Exchange (NYSE), (the major national exchange market, specifically an auction market since it does stock exchanges) has over _____ companies and accounts for more than _____ of the trading volume on all organized exchanges. A) 2,000, 60% B) 6,000, 80% C) 4,000, 70% D) 3,000, 80%
Answer: D) 3,000, 80% NYSE (over 3000 companies; more than 80% of the trading volume on all organized exchanges)
An important structural difference between exchanges and the OTC market is that: A) on exchanges there is only one market maker or dealer per stock. B) there is no restriction on the number of dealers per stock in the OTC market. C) the OTC market does not have listing requirements. D) A and B E) A and C
Answer: D) A and B An important structural difference between exchanges and the OTC market is that on exchanges there is only one market maker or dealer per stock AND there is no restriction on the number of dealers per stock in the OTC market. The OTC Market DOES have listing requirements.
Exchange Markets: A) The trading exchange is the market maker because the prices of securities such as shares, debentures, notes, corporate bonds, etc. are decided by the market demand and supply forces; B) Are mainly used by well established companies, over 3,000 (example: A company must have at least $4 million in shareholder's equity to be listed on the NYSE); C) The core function of an exchange is to ensure fair and orderly trading and the efficient dissemination of price information for any securities trading on that exchange (more transparent, more regulations); D) It can be a physical trading location such as premises, etc. or it can be an electronic platform, i.e. website; E) All the above F) A, B, & C
Answer: D) All of the above https://keydifferences.com/difference-between-otc-and-exchange.html
What are the benefits of the CMO design? A) It can create a variety of maturity dates to satisfy various investors' preferences. B) The size and value of its payments for each tranche is more certain than payments on its underlying mortgages. C) Compared with pass-throughs, CMOs reduce the uncertainty of maturity date due to prepayment risk. D) All of the above.
Answer: D) All of the above. Three main benefits of the CMO design: 1. It can create a variety of maturity dates to satisfy various investors' preferences. 2. The size and value of its payments for each tranche is more certain than payments on its underlying mortgages. 3. Compared with pass-throughs, CMOs reduce the uncertainty of maturity date due to prepayment risk
Which of the following factors affect the default risk? A) Level of equity invested by borrower. B) Borrower's income level. C) Borrower's credit history. D) All of the above.
Answer: D) All of the above. Factors that affect the default risk: 1. Level of equity invested by borrower This factor is reflected in the loan-to-value (LTV) ratio. The higher the LTV ratio, the higher the default risk. 2. Borrower's income level One usual measure is the payment-to-income (PTI) ratio. The lower the PTI ratio, the lower the default risk. 3. Borrower's credit history Borrowers with a history of credit problems are more likely to default on their mortgage loans than those without credit problems. Example: Low Credit Scores
A mortgage originator generates income from the following sources: A) origination fee B) secondary market profit C) servicing fee D) All of the above E) None of the above
Answer: D) All of the above. A mortgage originator generates income from the following sources: origination fee, secondary market profit, and servicing fee. In general, mortgage originators make money through the fees that are charged to originate a mortgage (origination & servicing fees) and the difference between the interest rate given to a borrower and the premium a secondary market will pay for that interest rate (secondary market profit).
What are the listing requirements for auction markets? A) Minimum asset requirements. B) Minimum capital requirements. C) Minimum number of shareholders requirements. D) All of the above. Bonus question: Who has more strict requirements? Regional exchanges or national exchanges?
Answer: D) All of the above. To be listed, a company must meet certain listing requirements set by the exchange, such as minimum assets, capital, and number of shareholders. Regional exchanges have less strict listing criteria than national exchanges. Firms can be listed on both national and regional exchanges at the same time (so called dual listings). Since transaction cost is lower at the regional exchanges, brokerage firms have an incentive to route orders of dually listed stocks to the regional exchanges.
Dealers A) buy for their own account; B) maintain an inventory of assets for transaction; C) earn profits from bid-ask spread (that is, selling assets at a higher price than they purchase them); D) All the above E) None of the above
Answer: D) All the above Dealers buy for their own account. Dealers maintain an inventory of assets for transaction. Dealers earn profits from bid-ask spread (that is, selling assets at a higher price than they purchase them). Dealers are also called principals.
Adjustable-Rate Mortgages (ARM): A) Are designed to resolve/alleviate the mismatch problem by matching mortgage rates with the short-term market interest rates; B) The borrower bears the interest rate risk (therefore, the default risk may increase as interest rates rise); C) Generally have caps that limit how much the interest rate and/or payments can rise per year or over the lifetime of the loan (with caps, the lender takes some of the interest rate risk); D) All the above. E) A & B
Answer: D) All the above. https://www.investopedia.com/terms/a/arm.asp
Fixed-Rate Mortgages (FRM): A) Are traditional mortgages are which are (1) fixed-rate, (2) fully amortized mortgages which require (3) level-payment; B) The lender bears the interest rate risk (therefore, longer term fixed-rate mortgages are more expensive); C) The mortgage is amortized (paid back) over time to the extent that the periodic payments exceed the interest due; D) All the above. E) A & C
Answer: D) All the above. https://www.investopedia.com/terms/f/fixed-rate_mortgage.asp
A best efforts offering is one where A) The underwriter bears the risk of an unsuccessful offering. B) The investment banker guarantees the price of the securities to the issuer C) The investment banker executes a principal transaction. D) The investment banker acts only as a distribution agent. E) The issue can only be privately placed.
Answer: D) The investment banker acts only as a distribution agent. A best efforts offering is one where the investment banker acts only as a distribution agent. In a best efforts offering, the underwriters do not agree to purchase all of the securities from the issuer. Underwriters agree to use their best efforts to sell the securities and act only as an agent of the issuer in marketing the securities to investors. An "underwriter" is the investment bank who buys the shares from the company and resells them to the public.
A Buy Stop Order: A) buy or sell immediately at the current market price. B) an order to buy at or below a specified price or to sell at or above a specified price. C) becomes a market order to sell a stock when its market price reaches or drops below a specified level. D) becomes a market order to buy a stock when its market price reaches or rises above a specified level. E) becomes a limit order when the stop price is reached.
Answer: D) becomes a market order to buy a stock when its market price reaches or rises above a specified level. A buy stop order becomes a market order to buy a stock when its market price reaches or rises above a specified level. - to limit losses on short sales, or - to buy a stock when its price starts to rise the type of orders for momentum investors?!
Brokers A) trade securities for others; B) do not maintain an inventory of assets for transaction; C) earn profits from brokerage fees/commission (fees charged executing a trade); D) All the above E) A & C
Answer: D, All the above. Brokers trade securities for others, do not maintain an inventory of assets for transaction, and earn profits from brokerage fees. Agency brokers do not hold inventory of the securities they buy and sell. Instead, they simply execute transactions on behalf of their clients. An agency broker would be tasked to find the best possible execution when filling a large order.
Conventional Mortgage: A) Is a home buyer's loan that is not offered or secured by a government entity. B) Potential borrowers need to complete an official mortgage application, supply required documents, credit history, and current credit score (these are the factors that affect default risk). C) Conventional loan interest rates tend to be lower than those of government-backed mortgages, such as FHA loans. D) All of the above. E) A & B
Answer: E) A & B Conventional loan interest rates tend to be HIGHER than those of government-backed mortgages, such as FHA loans.
(Type of Security Market) Direct Search Market: A) Buyers and sellers seek out each other. B) Trading is so infrequent that no third party has incentive to provide service to facilitate the trade. C) Is an intermediated market. D) An example of this is used car trading. E) A, C, and D.
Answer: E) A, B & D Is NOT an intermediated market (direct is in the name)
Freddie Mae Participation Certificate (PC): A) FHLMC was established to provide a secondary market for conventional mortgages typically originated by thrifts. B) Freddie Mac (FHLMC) issues pass through securities (called PCs) and uses the proceeds to finance the origination of conventional mortgages. C) Mortgages that are in the pool backing PCs can have different rates. D) A & B E) A, B & C
Answer: E) A, B, & C FHLMC was established to provide a secondary market for conventional mortgages typically originated by thrifts. Freddie Mac (FHLMC) issues pass through securities (called PCs) and uses the proceeds to finance the origination of conventional mortgages. Mortgages that are in the pool backing PCs can have DIFFERENT rates. Ginnie Mae = SAME RATES Freddie Mae and Privately Issued Pass-throughs= Different rates okay
Privately Issued Pass-through Security (PIP): A) PIPs are issued by various private institutions on pools of conventional mortgages which may have different rates. B) The mortgages backing the PIPs are insured through private insurance companies. C) Both PCs and PIPs are collateralized by conventional mortgages; D) PIPs are assembled by FHLMC; PCs are pooled by private institutions. E) A, B, and C. F) B, C, and D.
Answer: E) A, B, and C. Both PCs and PIPs are collateralized by conventional mortgages; PCs are are assembled by FHLMC; PIPS are pooled by private institutions. Privately Issued Pass-through Security (PIP): PIPs are issued by various private institutions on pools of conventional mortgages which may have DIFFERENT RATES. The mortgages backing the PIPs are insured through private insurance companies.
Collateralized Mortgage Obligation (CMO): A) A CMO provides for several classes (called tranches) of bondholders with sequential maturities. B) The distribution of principal repayment and prepayment is based on the priority of tranches. A lower tranche would not receive any principal until the entire principal of the higher tranche has been paid off. C) Different tranches are exposed to different degrees of prepayment risk. D) Each tranche receives periodic coupon interest payment based on the amount of remaining balance. E) All are correct. F) A, C & D.
Answer: E) All are correct. Collateralized Mortgage Obligation (CMO) Under a standard Mortgage back security, investors share proportionally in prepayments. *A CMO provides for several classes (called tranches) of bondholders with sequential maturities.* The distribution of principal repayment and prepayment is based on the priority of tranches. A lower tranche would not receive any principal until the entire principal of the higher tranche has been paid off. Different tranches are exposed to different degrees of prepayment risk. Each tranche receives periodic coupon interest payment based on the amount of remaining balance.
(Type of Security Market) Dealer Market: A) Dealers specialize in certain assets or commodities and they buy and sell from their own accounts. B) Dealers are compensated by price difference (profit margin). C) By posting bid and ask prices, they stand ready to trade and eliminate the time-consuming search for trading partners. D) The risk is that they do it with their own money, so if they don't make a profit it affects their own money. Liquidity risk too, which is why there are fast turn arounds. E) All of the above.
Answer: E) All of the above
Over The Counter Markets (OTC): A) Dealers act as market-makers by quoting prices at which they will buy and sell a security, currency, or other financial products; B) Are mainly used by small companies; C) are typically less transparent than exchanges and are also subject to fewer regulations (less liquid as a result, may have liquidity premiums); D) Do not have a physical location and transact directly via computer networks and phone; E) All the above F) A, C, & D
Answer: E) All of the above
(Type of Security Market) Brokered Market: A) Buyers and sellers are matched by brokers. B) Enough trading activities exist so that brokers can make a living by offering specialized search services to market participants. C) Brokers with their frequent contact with market participants have a better knowledge of the prevailing "fair" market price. D) Brokers are compensated by percentages (fees). E) All of the above.
Answer: E) All of the above Brokers don't buy the house themselves so they don't expose their money to risk. That is why they are compensated by percentages. Meanwhile, dealers are compensated by the price difference (profit margin)
(Type of Security Market) Auction Market: A) Trading takes place via centralized procedures. B) Market specialists determine prices using a set auction rule. C) High volume of trade or many interested participants are required. D) The cost to set up an auction market is the most out of these type of security markets. E) All of the above.
Answer: E) All of the above.
Mismatch Problem for Fixed Rate Mortgage Lenders: A) The assets are the mortgage loans; B) The liabilities are the deposits (examples: checking accounts, saving accounts, CDs). C) The mismatch is caused because the duration of the assets is greater than the duration of the liabilities. D) The assets are affected more by interest rate increases than liabilities. E) All of the above. F) A, B, & C
Answer: E) All of the above.
The OTC Market vs the Exchanges Market: A) Stocks not listed on exchanges are traded in the OTC markets. B) Unlike the organized exchanges, the OTC markets does not have a trading floor. C) The OTC market is primarily a dealer market, where the trades are completed through a computer network. D) One market maker (dealer) per stock on the exchange vs. multiple dealers per stock in the OTC market E) All of the above.
Answer: E) All of the above.
Securitization: A) is the process of transforming individual loan contracts into marketable securities. B) involves the pooling and repackaging of mortgage loans into securities; the securities are then sold to investors, who became the owners of the mortgage loans. C) Issuers create marketable financial instruments by merging various financial assets into tranches. D) Products with riskier underlying assets will pay a higher rate of return. E) All of the above. F) A & B
Answer: E) All of the above. Securitization is the process of transforming individual loan contracts into marketable securities. Securitization involves the pooling and repackaging of mortgage loans into securities; the securities are then sold to investors, who became the owners of the mortgage loans. Issuers create marketable financial instruments by merging various financial assets into tranches. Products with riskier underlying assets will pay a higher rate of return.
Commission depends on what factors? A) The commission structure depends on type of securities. B) The commission structure depends on the number of shares. C) The commission structure depends on type of broker. D) The commission structure depends on the stock price level. E) All of the above. F) A, B, and C.
Answer: E) All of the above. The commission structure depends on type of securities and type of broker. It also depends on the number of shares and the stock price level. Brokers are compensated by percentages. Meanwhile, dealers are compensated by the price difference (profit margin) The introduction of negotiated commissions (in May 1975) has reduced the trading costs for institutional investors and wealthy individuals, but not so beneficial for small investors
Ginnie Mae (GNMA): A) issues pass-through securities on pools of FHA and VA mortgages with the different rates and originators. B) GNMA guarantees timely payment of principal and interest to investors who purchase the securities issued by them. (FHA and VA insurance plus GNMA guarantee.) C) GNMA would charge a fee equal to 0.5 to 1 percent to cover the guarantee service; D) A & C E) B & C
Answer: E) B & C Ginnie Mae issues pass-through securities on pools of FHA and VA mortgages with the SAME rate and originator. GNMA guarantees timely payment of principal and interest to investors who purchase the securities issued by them.FHA and VA insurance plus GNMA guarantee. GNMA would charge a fee equal to 0.5 to 1 percent to cover the guarantee service;
Stop-Limit Order: A) buy or sell immediately at the current market price. B) an order to buy at or below a specified price or to sell at or above a specified price. C) becomes a market order to sell a stock when its market price reaches or drops below a specified level. D) becomes a market order to buy a stock when its market price reaches or rises above a specified level. E) becomes a limit order when the stop price is reached.
Answer: E) becomes a limit order when the stop price is reached. In contrast to a stop order, a stop-limit order becomes a limit order when the stop price is reached. Investors can limit the possible execution price after the activation of a stop.
Employee Retirement Income Security Act (ERISA) established all but which one of the following? A. Prudent man rule B. Maximum vesting times C. Minimum funding requirements D. Insurance for pension plan participants E. Minimum payouts for defined contribution plans
Answer: E. Minimum payouts for defined contribution plans Employee Retirement Income Security Act (ERISA) established all BUT minimum payouts for defined contribution plans. Employee Retirement Income Security Act (ERISA) of 1974 is the major piece of regulation that covers pension funds. Five major provisions of ERISA include: 1) Minimum Funding - ERISA established guidelines for funding and set penalties for fund deficiencies. 2)Vesting Period - ERISA established maximum time period for vesting (10 years). 3) Fiduciary Responsibilities - ERISA set guidelines governing the pension plan management and investment (prudent man rule). 4) Transferability - ERISA allows employees to transfer pension benefits from one employer to another when changing jobs. 5) Pension Fund Insurance - ERISA established the Pension Benefit Guarantee Corporation (PBGC) PBGC insures participants of defined benefit pension plans.
Bid-Ask Spread & Price: A) refers to a two-way price quotation that indicates the best potential price at which a security can be sold and bought at a given point in time. B) When the bid and ask prices are very close (narrow), this typically means that there is ample liquidity in the security. C) When the bid and ask prices are wide, this typically means that there is little liquidity in the security, it is hard to trade and time consuming. D) Bid and ask prices are set by an analyst. E) All of the above. F) A, B, and C.
Answer: F) A, B, and C. Bid and ask prices are set by the market, supply and demand. https://www.investopedia.com/terms/b/bid-and-ask.asp
Firm Commitment: A) The investment bank agrees to buy the securities from the issuer at an agreed-upon price. B) The underwriter bears the price risk of selling the securities at a lower price. C) An underwriter is an agent/broker. D) Investment Banks act as principals earning the price discount (bid-ask spread). E) All of the above. F) A, B, and D.
Answer: F) A, B, and D. A firm underwriting is also known as a principal or dealer transaction. Because the investment bank is paying the principal and making the deal (taking on the burden). Firm commitment: the IB agrees to buy the securities from the issuer at an agreed-upon price The underwriter bears the price risk of selling the securities at a lower price. IBs act as principals earning the price discount (bid ask spread), more risk more reward.
True or False: With Fixed-Rate Mortgages, the lender bears the interest rate risk.
Answer: True Due to the mismatch problem with interest, the real burden of mortgage payments is tilted toward the early years of the mortgage life.
A collateralized mortgage obligation (CMO) A) reduces the uncertainty concerning the maturity of a mortgage‑ backed security. B) provides a risk/return pattern not available with typical mortgage pass‑through securities. C) is a security backed by a pool of mortgage pass‑through securities or mortgages. D) all of the above E) none of the above
Answer:D) all of the above A collateralized mortgage obligation (CMO) reduces the uncertainty concerning the maturity of a mortgage‑ backed security. A collateralized mortgage obligation (CMO) provides a risk/return pattern not available with typical mortgage pass‑through securities. A collateralized mortgage obligation (CMO) is a security backed by a pool of mortgage pass‑through securities or mortgages.
Interest Rate & Prepayment Risk: Although default risk is low for mortgages, interest rate risk is the major concern for investors in mortgages. Owners (investors) of mortgages may lose no matter which way interest rates move. What happens to prepayment when interest rates rise? (prepayments are paying extra on their monthly payments towards the principal of the loan.)
As interest rates rise, prepayment models factor in fewer prepayments because people are generally not interested in exchanging their current mortgage for one with a higher interest rate and monthly payment. If interest rates increase, the homeowner will have an incentive to repay the home loan more quickly to avoid higher future interest payments. In this scenario, making principal payments earlier will reduce future interest payments and increase the prepayment risk for the lender.
Stock exchanges operate in the form of a
Auction Market Stock exchanges operate in the form of an auction market. Auction markets have to have large trading volumes to be maintained, and stock markets do.
Who does a broker trade securities for? Who does a dealer trade securities for?
Broker = trades for others (makes them broker) Dealer = trades for themselves (wants the best deal) A broker is an individual or financial services company that enables the trading of securities for other individuals. A broker executes orders on behalf of clients. To the regulators, this means the entity through which investors hold a brokerage account. The terms "agent" and "broker" can be used interchangeably. A dealer is an individual or financial services company that enables the trading of securities for themselves. The terms "principal" and "dealer" can be used interchangeably.
THIS WILL BE ON THE EXAM: Comparison between Broker and Dealer Markets. Why are dealers and brokers compensated differently and how are they compensated?
Brokers don't buy the house themselves so they don't expose their money to risk. That is why they are compensated by percentages. Meanwhile, dealers are compensated by the price difference (profit margin) More risk, more reward.
Mortgage pass-through securities pass through all interest and principal payments on pools of mortgages to holders of security interests in the pool on a pro rata basis. What are the five common types of mortgage pass-through securities?
Common types of mortgage pass-through securities: 1. Ginnie Mae MBS 2. Freddie Mae participation certificate (PC) 3. Privately issued pass-through (PIP) 4. Collateralized mortgage obligation 5. Stripped Mortgage-Backed Securities
The OTC Market operates in the form of a
Dealer Market The OTC market is primarily a dealer market, where the trades are completed through a computer network.
Investment Risks in Mortgages: What is Default Risk?
Default risk is the risk that a lender takes on in the chance that a borrower will be unable to make the required payments on their debt obligation. Lenders and investors are exposed to default risk in virtually all forms of credit extensions
What are the differences between Federally Insured Mortgages and Conventional Mortgages? Which one is insured? What are the interest rate differences? What are the differences in standards/qualifications? source: https://www.investopedia.com/ask/answers/082616/whats-difference-between-fha-and-conventional-loans.asp#:~:text=Unlike%20FHA%20loans%2C%20conventional%20loans,put%20down%20less%20than%2020%25.
FHA loans are backed by the Federal Housing Administration and offered by FHA-approved lenders. Unlike FHA loans, conventional loans are not insured or guaranteed by the government. FHA loans allow smaller down payments (as low as 3.5%) and lower credit scores than most conventional loans. Conventional loans typically cost less than FHA loans, but they can be harder to qualify for. Mortgage insurance is mandatory with FHA loans; you can avoid it on a conventional loan by putting down at least 20%.
When interest rates fall, what happens to principal repayments? Source: https://www.investopedia.com/terms/p/prepayment-model.asp#:~:text=As%20interest%20rates%20rise%2C%20prepayment,interest%20rate%20and%20monthly%20payment.
In general, homeowners with a higher interest rate will pay more in interest than principal for a longer time than those with lower interest rates. When interest rates fall, people will increase their principal repayments and possibly refinance. Lower interest rates help the borrower (they save more) and harm the lender (they make less). If interest rates fall, the opposite effect is accounted for, as more people will refinance their loans in an effort to close out their existing mortgage in favor of one with a lower interest rate and monthly payment.
The secondary market includes the dealer market and the auction market. What are the distinctions between these two categories? Where are they located? How do they operate? How do they earn profits? What are examples of each?
In the auction market, all individuals and institutions that want to trade securities congregate in one area and announce the prices at which they are willing to buy and sell. These are referred to as bid and ask prices. Example: New York Stock Exchange. A dealer market does not require parties to converge in a central location. Rather, participants in the market are joined through electronic networks. The dealers hold an inventory of security, then stand ready to buy or sell with market participants. These dealers earn profits through the spread between the prices at which they buy and sell securities. Bonds and foreign exchanges trade primarily in dealer markets, and stock trading on the Nasdaq is a prime example of an equity dealer market.
When interest rates fall, what would borrowers typically do with their mortgages? Source: https://www.investopedia.com/terms/p/prepayment-model.asp#:~:text=As%20interest%20rates%20rise%2C%20prepayment,interest%20rate%20and%20monthly%20payment.
Low interest rates tend to increase demand for property, driving up prices, while high interest rates generally do the opposite. Borrowers will typically refinance their mortgages at a lower interest rate. This hurts the lender, since they are now profiting less in interest. For example, a homeowner who takes out a mortgage at 7% has a much stronger incentive to refinance after rates drop to 4% or 5%. When and if the homeowner refinances, those who invested in the original mortgage on the secondary market do not receive the full term of interest payments. If they wish to keep investing in the mortgage market, they will have to accept lower interest rates or higher default risk.
Mismatch Problem for Fixed Rate Mortgage Lenders: For lending institutions, deposits are primarily short-term, but their holdings of fixed-rate mortgages are long-term. mismatch in maturities of assets (mortgages) and liabilities (deposits); their asset portfolios are exposed to interest rate risk. When interest rates rise, how does it effect their balance sheet?
On the balance sheet, as the interest rates rise, the market value of the assets may drop below the book value of its liabilities. As Interest Rate + (Increase), Market Value of Assets - (Decrease)
Mismatch Problem for Fixed Rate Mortgage Lenders: For lending institutions, deposits are primarily short-term, but their holdings of fixed-rate mortgages are long-term. mismatch in maturities of assets (mortgages) and liabilities (deposits); their asset portfolios are exposed to interest rate risk. When interest rates rise, how does it effect their income statement?
On the income statement, the revenue generated from the fixed-rate mortgages may not be enough to cover the costs of the funds (deposits) when interest rates rise. Interest Rates + (Increase), Revenue < Cost of the Funds/Deposits
What's the difference between exchange and OTC markets? Source: https://keydifferences.com/difference-between-otc-and-exchange.html
Over the Counter or OTC is a decentralized dealer market wherein brokers and dealers transact directly via computer networks and phone. - Over-the-counter markets are those in which participants trade directly between two parties, without the use of a central exchange or other third party. - OTC markets do not have physical locations. - Some of the products most commonly traded over-the-counter include bonds, derivatives, structured products, and currencies. Exchange is an organized and regulated market, wherein trading of stocks takes place between buyers and sellers in a safe, transparent and systematic manner. - Exchanges are marketplaces for the trade of securities, commodities, derivatives, and other financial instruments. - Companies may use an exchange to raise capital. - A company must have at least $4 million in shareholder's equity to be listed on the New York Stock Exchange. - More than 80% of trading on the New York Stock Exchange is done electronically (used to be more in-person, unlike OTC).
What is prepayment risk?
Prepayment risk is the risk involved with the premature return of principal on a fixed-income security. Prepayment risk exists in some callable fixed-income securities that may be paid off early by the borrower.
Other Mortgage Designs: What is a Reverse Annuity Mortgage (RAM)?
RAMs are designed for older homeowners who need additional funds to meet living expenses but do not want to sell their homes. RAMs allow people to borrow against the equity in their homes at relatively low interest rate (like a secured loan). Only do this if desperate.
Mismatch Problem for Fixed Rate Mortgage Lenders: When interest rates increase, the market value for both assets and liabilities decrease. But which one decreases more?
The mortgage market's value decreases more with interest rates due to the duration of the mortgage loans.
What does the bid-ask price mean in Exchange markets?
The prices of securities such as shares, debentures, notes, corporate bonds, etc. are decided by the market demand and supply forces. The bid price is what the dealer is willing to pay for a currency, while the ask price is the rate at which a dealer will sell the same currency.
Everything from here on out are added questions, not created by the professor. What's are the distinctions between primary market and secondary market? Who is the primary beneficiary from each market? What is the objective of each market? What does each market include (trade)?
The primary market is where securities are created, while the secondary market is where those securities are traded by investors. In the primary market, companies sell new stocks and bonds to the public for the first time, such as with an initial public offering (IPO). The important thing to understand about the primary market is that securities are purchased directly from an issuer. The secondary market is basically the stock market and refers to the New York Stock Exchange, the Nasdaq, and other exchanges worldwide. The secondary market includes the Dealer Market and the Auction Market.
You plan to purchase a $500,000 home with a 20% down payment. You can take out a 30-year Fixed Rate Mortgage (FRM) of $400,000 at an APR of 7.2%. a. What is your monthly payment? b. If you make regular monthly payments, how long will it take to pay off half of the loan? (i.e., reduce the principle of the loan balance to half) c. After making regular monthly payments for 10 years, how much will be the loan balance?
a. Monthly payment: 7.2% = 0.6% (monthly rate) APV= C/r[1 - (1/(1+r)^t)] 40,000 = C/0.006[1-1/(1+0.006)^360] I/r = 0.6, N=350, c= annuity, (CPT) PMT = $2,715.16 APR = PR * M PR = APR/m = 7.2%/12 = 0.6% The loan balance is the present value of all of the fixed monthly payments. b. It takes about 2/3rd of the time to pay off half of the loan. This is due to the interest rate. It is decreasing at a limited rate. remaining balance = $200,000 $200,000 = 2,715.16/0.006 [1- (1/(1.006)^t)] Solve for t = 97.5 months 360 - 97.5 = 262.5 months = 21.9 years c. PV? PMT = -$2,715.16 I/Y = 0.6 N = 240 the Present Value (PV) is $344.848
You plan to purchase a $500,000 home with a 20% down payment. You can take out a 30-year Fixed Rate Mortgage (FRM) of $400,000 at an APR of 7.2%. d. Assume you obtain two quotes with and without (discount) points: either 7.2% APR without point or 6% with 2.5 points. For the 6% APR loan with 2.5 points, how much do you need to pay for the points? e. What is the NPV of paying the points? (i.e., the PV of savings in monthly payments over the life of the mortgage loan net of the initial payment for points)
d. 2.5% * $400,000 = $10,000 e. step one: Calculate the new monthly payment. PMT = 6%. 6%/12% = 0.5% APV= C/r[1-(1/(1+r)^t)] 40,000 = C/0.005 [1-1/((1+0.005)^360)] = $2,398.20 = PMT step two: Find the Savings & NPV. Savings = $316.96 per month. NPV = -10,000 + APV($316.96, 0.5%, 360 months) NPV = -10,000 + 316.960.005[(1-(1/(1+0.005)^360)] NPV = -10,000 + $52,866.28 NPV = $42,866.28
You plan to purchase a $500,000 home with a 20% down payment. You can take out a 30-year Fixed Rate Mortgage (FRM) of $400,000 at an APR of 7.2%. How long must you stay in the house to make it worthwhile to pay the points to lower down the interest rate, assuming the savings in payments can be reinvested at the same rate?
f. "If the borrower expects to live in the house for the breakeven number of months or longer, it is worthwhile to pay the points" NPV = -10,000 + APV($316.96, 0.5%, t months)=0 Solve for t, need to stay longer than t for the investment to be worth it. PV = -10,000 PMT = 316.96 I/Y=0.5 CPT t = 34.42 months, 3 years, if you live there longer than 34.42 months, then it is worth it.
