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For the first three years of the loan, the borrower will pay the monthly payment that would result if a teaser rate of 2.5% per year was applied to the entire 360-month term. But the low payment and teaser rate do not last the full 360 months and in fact the borrower is actually being charged a much higher rate of interest during this first phase. After the first 36 payments, the interest rate will become 11%, the rate of return demanded by the market for the risks posed by the sub-prime borrower, and the loans monthly payment will increase. The new rate will remain in effect for the remainder of the loan. Calculate the loans balance after the 36 th payment is made. a. $232,561 b. $262,361 c. $305,314 d. $326,321 2. Using the information in Question #1, calculate the new monthly payment (beginning in month 37). a. $2,249 b. $1,297 c. $2,952 d. $2,908 3. A bank makes a 360-month mortgage loan to a traditional (Prime) borrower. The cost of the house was $300,000 and the original amount of the loan was $240,000. The bank charged the borrower an interest rate of 6%, which was a fair rate at the time. The bank wants to explore the likelihood that the borrower will enter the danger zone after two years, danger zone meaning that the borrower will owe a balance that is $10,000 or more higher than the houses market value --- in other words the homes market value is more than $10,000 underwater or below the waterline. With a home at that value, this would then be a loan at a very high level of risk. By how much would the house have to change in value each year for two consecutive years for the loan to be considered as very high risk by the bank? a. -13.6% b. -7.2% c. -11.7% d. -9.2%

4. (Worth 2 points) Consider two different loans that you could use to purchase a home worth $400,000: i. A 360-month loan that requires a 20% downpayment and has an intro rate of i=1% for two years ...and then i=7% thereafter. ii. A loan that requires a 2% downpayment and has a fixed rate of 7% across all of its 360-month term. Which of the following statements is true regarding the default risk that an issuing bank would face related to the potential for underwater issues? Try using your intuition to answer this question...try drawing a rough graph of how balance would change for the two loans across time. a. Loan I has a greater chance of becoming underwater at month 36. b. Loan II has a greater chance of becoming underwater at month 36.

c. Neither loan is more likely to be underwater than the other at month 36. 5. (Worth 3 points) A subprime teaser loan starts with a loan amount of 220,000, n=360 and a teaser rate of 1.5% to be applied for 24 months. The hidden true rate is 7.6% and this is what really will be charged (behind the scenes) in phase 1 and upfront and disclosed in phase 2. If this home value is currently 230,000, then the loans balance will quickly rise above this 230,000 value. How long does it take (from the start of the loan) for the loans balance to finally drop back under $230,000 again? a. 49 months b. 47 months c. 56 months d. 52 months For Questions 6-8, consider the following table of data for a sample of bonds:

All bonds have a face value of $1,000

6. What is the maturity risk premium for the 20-year Treasury bond? a. 1.58% b. 1.66% c. 1.71% d. 1.79%

7. (Worth 2 points) What is the maturity risk premium for Corporate Bond X? a. 1.58% b. 3.51% c. 1.66% d. You cant find an answer just from the information that is given 8. What intrinsic value would you assign to the 5-year T-Note? a. $993.47 b. $997.11 c. $1,000.00 d. $1,006.56 9. If the yield curve that applies to current markets is an inverted type yield curve, then which of the following is true about investors perceptions of the annual risk free rate during future 1-year periods. a. They expect the risk free rate to, on average, stay at the same rate in future one-year periods. b. They expect the risk free rate to, on average, grow larger in future one-year periods. c. They expect the risk free rate to, on average, grow smaller in future one-year periods.

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