BUS 410 QUIZ QUESTIONS WELL ANSWERED LATEST UPDATE 2026

BUS 410 QUIZ QUESTIONS WELL ANSWERED LATEST UPDATE 2026 Mortgages - Answers loans to individuals or businesses to purchase homes, land, or other real property • Four basic types of mortgages are issued by U.S. financial institutions - Answers 1) home mortgages are used to purchase one- to four-family dwellings (called "single-family mortgages") - 75% 2) multifamily dwellings mortgages are used to purchase apartment complexes, townhouses, and condominiums - 17% 3) commercial mortgages are used to finance the purchase of real estate for business purposes - 7% 4) farm mortgages are used to finance the purchase of farms The key difference between US and Canada - Answers interest on mortgages is tax deductible in the US. - Interest on up to $750,000 of mortgage debt is deductible. Mortgage Refinancing (Prepayment) - Answers • Mortgage Prepayment happens when a borrower takes out a new mortgage and uses the proceeds to pay off an existing mortgage - mortgages are most often refinanced when an existing mortgage has a higher interest rate than current rates - In Canada, mortgages can be open or closed. Open mortgages allow prepayments without penalties. Closed mortgages charge steep prepayment penalties, e.g., an interest rate differential between your mortgage rate and the current market rate multiplied by the outstanding balance and remaining months to maturity. If you buy a new house you can port your mortgage to the new house, avoid the prepayment penalty. Mortgage types: Interest rates - Answers • Fixed-rate mortgages • Adjustable-rate mortgages Fixed-rate mortgages - Answers lock in the borrower's interest rate - required monthly payments are fixed over the life of the mortgage. - lenders assume interest rate risk Adjustable-rate mortgages - Answers (ARMs) tie the borrower's interest rate to some market interest rate or index - required monthly payments can change over the life of the mortgage, although they may initially be fixed for a set time period. • For example, hybrid ARMs: 5/1 (fixed rate for 5 years, then rate reset every year) are popular in the US. - borrowers assume interest rate risk with an ARM - ARMs can increase default risk • Canada. All mortgages in Canada are ARMs from the US perspective. - Fixed rate mortgages: the rate resets only at the end of the term (every 3-10 years, 5yrs most typical). - Variable rate mortgages: the rate changes any time the prime rate changes Mortgage types - Answers • Subprime mortgages - Subprime mortgages are mortgages whose borrowers do not qualify for a 'prime' credit rating because of their low FICO credit scores (arising from prior credit problems, such as delinquencies and defaults; or they may simply lack sufficient credit history or have insufficient income). - Beginning in 2006, problems in the subprime mortgage market led to the financial crisis of 2007 and 2008 • Second mortgage: home equity loan vs. home equity line of credit (HELOC) - Are similar in that they are loans secured by the property value. - Second mortgage is a subordinated claim to the first mortgage - Home equity loan is lump sum vs. HELOC is a line of credit • Reverse-annuity mortgages (RAMs) - Retirees or homeowners with a substantial amount of equity in their home can sell the equity back to a bank, and the bank makes monthly payments over time Secondary Mortgage Markets and Securitization - Answers • FIs remove mortgages from their balance sheets through one of two mechanisms - by pooling recently originated mortgages together and selling them in the secondary market - by securitizing mortgages (i.e., by issuing securities backed by the mortgages) - Securitization is a capital market activity in which assets (liabilities) that generate cash flows are pooled and used to create new, marketable securities. - In 2007, 40% of mortgages were securitized in the US, only 3% in Canada. • FIs can reduce the liquidity risk, interest rate risk, and credit risk of their loan portfolios by removing mortgages from their balance sheet. Securitization - Answers • Types of asset-backed securities: • Securities backed by mortgage cash flows (CFs) are called mortgage-backed securities (MBS) • securities backed by bond or other debt CFs are called collateralized debt obligations (CDOs) - The underlying collateral that generates the CFs can be bonds, loans, insurance, tranches of ABS/MBS/CDO, credit derivatives such as credit default swaps. • securities backed by all other assets (e.g., leases, patent royalties, whiskey sales) are simply called asset-backed securities (ABS) Special Purpose Vehicles (SPV, SPE) - used in securitization - Answers • SPVs are companies created by a sponsor company (e.g., a bank) to hold and service assets or liabilities that the sponsor transfers or sells to it. - Example. A bank creates an SPV and sells it mortgages originated by the bank. The SPV creates an MBS and sells its CFs (tranches) to investors. • SPVs are like shell companies - they typically have no employees, have no physical location, and make no decisions (automatized to perform only the function they are created for). • The sponsor company benefits - the assets/liabilities are removed from its balance sheet. - when assets are sold the sponsor has its capital requirements reduced and leverage reduced, allowing for more lending. - bankruptcy-remotedness. SPVs are structured so that they cannot go bankrupt even if the sponsor goes bankrupt. - the sponsor can earn a fee (off-balance-sheet income) for servicing the securitized assets held by SPV. Two Types of Mortgage-Backed Securities (MBS) - Answers • Pass-through mortgage-backed securities "pass through" promised principal and interest payments to investors - Each investor receives a pro rata share of the CFs from the underlying pool of mortgages. - There is only one class of bond holders • Collateralized mortgage obligations (CMOs) are multiclass MBS with multiple bond holder classes or tranches CMO tranche types - Answers CMO tranches are created depending on the issuer and investor objectives and wishes - Term Preferences - Duration - Credit Risk - CF volatility, prepayment risk Term Preferences - Answers Tranches pay and mature sequentially. E.g., tranches F2, F3, ... receive principal CFs only after tranche F1 is retired. This is called a plain-vanilla CMO. Duration - Answers Floater: yield=LIBOR, Inverse Floater: yield=8%-LIBOR. Interest only and principal only (IO & PO) tranches. Credit Risk - Answers Senior and subordinated tranches. Defaults in the mtg pool reduce CFs to subordinated tranches first and do not affect senior tranches if subordinated tranches still exist. CF volatility, prepayment risk - Answers PAC (planned amortization class), TAC (targeted amortization class) put upper and/or lower bounds on the principal prepayment speed - PAC/TAC tranches have companion tranches that absorb extra CFs of potentially faster prepayments. Mutual Funds - Answers • Mutual funds pool the resources of many small investors by selling them shares and using the proceeds to buy securities. • The first mutual fund similar to the funds of today was introduced in Boston in 1924. • Ownership in mutual funds has increased dramatically - In 1980, only 5.7% of households held mutual fund shares. In 2013, that number was 45%. - 7700 MFs in the US, 2900 in Canada in 2013. • MFs are the second most important group of FIs as measured by asset size (second only to commercial banks) Mutual funds are financial intermediaries because they - Answers - allow investors participate in large equity and debt offerings that, individually, require more capital than they possess - provide diversification even for small investments - conduct trades at low transaction costs - use professional money managers Calculating a Mutual Fund's Net Asset Value (NAV) - Answers • NAV is the total value of the mutual fund's assets (stocks, bonds, cash, and other assets) minus any liabilities such as accrued fees, divided by the number of shares outstanding. - It is determined daily based on prices at market close Stocks $35,000,000 Bonds $15,000,000 Cash $3,000,000 Total value of assets $53,000,000 Liabilities -$800,000 Net worth $52,200,000 Outstanding shares 15 million NAV = $52,200,000/15,000,000 = $3.48 Types of funds - Answers Active management - Open-ended structure - Closed-ended structure Passive management - ETF's - Index mutual funds Asset Class - Equity - Bonds - Balanced - Money Market - Alternate Closed-End Funds - Answers a fixed number of shares are sold through an initial offering and are then traded in the market. - The price for the shares is determined by supply and demand forces on the stock exchange. - Pros: when investors sell their shares of the fund, there is no need for the managers to change its investments - Cons: • Difficult for the fund to add new money to expand portfolio (the fund needs to conduct an SEO); • big discrepancies can arise between the fund's stock price and the NAV. A fund can sell at a premium (PriceNAV) or discount (Price Example. Premium/discount: Nuveen Multi-Market Income Fund Open-End Mutual Fund - Answers a fund for which the supply of shares is not fixed but can increase or decrease daily with purchases and redemptions of shares by investors. - The most common type - Shares are bought from/sold to the mutual fund directly. - The price is equal to the NAV of the fund. - Pros: the fund can grow easily - Cons: it has to rebalance its investments in response to money inflows or outflows - Investors place trades during trading hours but find out their per unit price only after closing - when the NAV has been calculated.