You are on page 1of 5

1.

2.

-Consider a construction loan made to Middleton Development Co. The loan amount is $6 million,
which will be drawn evenly (i.e., a $1,000,000 monthly draw) during the next six months to redevelop
an existing apartment building. Note that each disbursement occurs at the end of the month. The
annualized interest rate is expected to remain the same at 6% for the first three (3) months. For the next
three (3) months, the annualized interest rate will be 8%. What is the total loan amount (including
interest) required to finance this project and what is the total interest carry?
Refer Excel file tab Answer 1
Month

Draws

Interest Carry

Cumulative Loan Bal.

$1,000,000

$nil

$1,000,000

$1,000,000

$5,000

$2,005,000

$1,000,000

$10,000

$3,015,000

$1,000,000

$20,000

$4,035,000

$1,000,000

$26,667

$5,061,667

$1,000,000

$33,333

$6,095,000

Total

$6,000,000

$95,000

$6,095,000

A multifamily property is expected to produce the following income stream over the next three years:
Year
1
2
3

NOI
$575,000
600,000
625,000

A lender is willing to make a $6,000,000 participation mortgage, at 6% interest rate, a 30 year


amortization period, with a balloon payment at the end of year 3. For simplicity, annual compounding
for this mortgage is assumed.In addition, the lender gets 10 % of each year's net operating income, and
20% of thenet sales proceeds (note: the net sales proceeds will be calculated as: the sales proceeds - the
selling expenses - the mortgage balance). The purchase price of the property is $8 million. The investor
of the property expects to sell the property for $9 million at the end of the third year with the selling
expenses of 5.5% (based on the sales price).
a)

Calculate the before-taxmortgage yield for the loan, assuming that the loan is held for 3 years. (5pts)
Ans- Refer Excel File tab answer 2

b)

What is lenders before-tax mortgage yield if the property ends up with selling for $8million at the
end of the third year, instead of selling for $9 million? (5 pts)
Ans Refer Excel File tab answer 2

c)

Why do lenders issue participation loans? What are the benefits and risks associated with this type of
loans for borrowers and lenders? Briefly discuss. (5pts)

Ans- Participation loans are loans made by multiple lenders to a single borrower. Several banks might chip
in to fund and form one extremely large loan, with one of the banks taking the role of the lead bank. This
lending institution then recruits other banks to participate and share the risks and profits. Because of this
sharing of risk the lenders prefer participation loans.
Benefits for the lenders
Selling loan participations allows the lead bank to originate an exceptionally large loan that would
otherwise be too large for it to handle by itself.
The lender bank can diversify the risk.
The lender bank can participate in big ventures through these kinds of loans, which individually
for the lender is not possible.
Risk for the lenders
The participants bank does not have any direct right against the borrowers.
Some times the participation agreements can be quite complex and require substantial negotiation,
Risk to the borrowers
Reduces competitions among banks
Benefits to the borrowers
Better banking facilities.
Can get large loans.
1.

You are a mortgage banker at TD Bank in Miami. One borrower wants to borrow money from
your bank to finance his new home. He just finds a new job and plans to buy the house at a price
of $300,000. He wants to borrow a 80% loan topurchase the home. You tell him that a constant
payment, 30 year amortization period, fully amortizing loan (FRM)is available. The interest rate
for the loan is 4.5%, which is the same as the market interest rate.Moreover, you will charge a loan
origination fee of 3% for the loan.

(a) What is the monthly payment for the loan? [3pts]


Ans- Refer Excel file tab Answer 2 part 1

(b) What is the effective interest rate,assuming the mortgage is paid off after 30 years? [3pts]
Ans- Refer Excel file tab Answer 2 part 1

(c) If the borrower plans to repay the loan after three years, what is the effective interest rate? [3pts]
Ans- Refer Excel file tab Answer 2 part 1
(d) If the borrower wants to borrow a 90% loan, the loan rate will be 5.5%. Everything else being
equal (i.e., he prepays the loan after 3 years, with the 3% loan fee), would you recommend him to
borrow the 90% loan? [3pts]
Ans- Refer Excel file tab Answer 2 part 1
(e) Suppose the borrower can get a loan with a below-market interest rate from the homebuilder. This
fully amortizing FRM loan will have a 80% LTV, 4% interest rate, 30 years amortization period,
and with no loan fees. At what price should the homebuilder sell the home to the borrower in order
to earn the market rate of interest (4.5%) on the loan? Assume the borrower would hold the loan

for the entire term of 30 years and the home would normally sell for $300,000 without any special
financing. [3pts]
Ans- Refer Excel file tab Answer 2 part 1

3.

Wells Fargo issues a CMBS security. The mortgages in the pool are interest only loans, with a total
loan amount of $15 million. For simplicity, assume that the interest rate for the mortgages is 11%, and
the loan maturity is 4 years. Further, assume that the mortgages are annually compounded.
The bank issues three tranches of securities based on the mortgage pool: i) Senior Class or Tranche A,
with an amount of $10 million at 8% coupon rate; ii) Subordinated Class or Trance B, with an amount
of $3 million at 10% coupon rate; and iii) Residual tranche, with an amount of $2 million. These
securities have a maturity of four years.
a.
b.

Suppose that there is no default in the mortgage pool over the four year period. Calculate the
returns for the investors who purchase the three tranches of securities. (5 pts)
Now assume thatthe value of the properties associated with the mortgage pool at the end of the
fourth year is only 80% of the outstanding loan balance. What are the returns for the investors for
the three tranches of securities? (5 pts)

a.)
Year

CF from the pool

Senior Class

Subordinated Class

Residual Class

$1.65m

$0.8m

$0.3m

$0.55m

$1.85m

$0.8m

$0.3m

$0.73m

$2.03m

$0.8m

$0.3m

$0.93m

$2.27m

$0.8m

$0.3m

$1.15m

Return =

$7.77m

$3.2m

$1.2m

$3.37m

Year

CF from the pool

Senior Class

Subordinated Class

Residual Class

$1.65m

$0.8m

$0.3m

$0.55m

$1.85m

$0.8m

$0.3m

$0.73m

$2.03m

$0.8m

$0.3m

$0.93m

$2.27m

$0.8m

$0.3m

Return =

$7.77m

$3.2m

$1.2m

$2.21m

b.)

4.

Bank of America issues a MBS security based on a mortgage pool with the following terms:

Mortgage pool value


Mortgage interest rate
Loan Term 3 years

$25,000,000
6.5%

a)

Suppose that the MBS has only one class of security, i.e., the basic MBS discussed during the class.
What is the price of this MBS if the market interest rate is 6%? Assume annual compounding as
well as a constant annual prepayment rate of 10% (based on the outstanding loan amount at the
beginning of each year, the same as we discussed during the class). (5pts)

b)

Why is MBS considered a callable bond? How can this callable feature affect MBS pricing?
Briefly discuss. (5pts)

Now, another investment bank suggests that, instead of issuing the single-class MBS security as above,
two classes of securities can be issued based on the same mortgage pool, i.e., an IO and a PO security.
c)

Determine the price of the IO and PO security, assuming that there is no prepayment. Further assume
that the IO investors require a market rate of return of 4.5% and the PO investors require a market
return of 6%. (5pts)
Now suppose future interest rate will fall, so there is a 15% prepayment for each year (again, prepayment
calculation is based on the loan balance at the beginning of the year). The IO and PO investors require a
market rate of return of 4% and 5.5%, respectively. Determine the prices of the IO and the PO security.
(5pts)
Ans: In the attached excel sheet named Answer 4
5.

Luistook a mortgage loan 5 years ago for $120,000 at 7% interest for 15 years, to be paid in monthly
payments. Now, a lender is offering him a new mortgage loan at 5% for 10 years. The new loan
amount is $92,895, the outstanding loan balance of the existing loan. Suppose that a prepayment
penalty of 3 % must be paid if Luis refinances the existing loan. Moreover, the lender who is making
the new loan requires an origination fee of $3,000. Luis plans to hold the property for 10 years. Note:
in this case, Luis has to pay the refinancing fees (i.e., the origination fee and the prepayment penalty)
out of his pocket.

(a) What is the total financing cost (not include the loan amount itself)if Luis decides to refinance the
old loan? [2pts]
Answer Refer Excel Sheet Tab- Answer 5

(b) Given the information provided here, should Luis refinance? Please support your answer by
calculating the effective interest rate of the new loan. [5pts]
Answer Refer Excel Sheet Tab- Answer 5

(c) Now suppose thatLuiss current income is low. The new lender allows him to pay a monthly
payment of $200 for the new loan (i.e., the actual monthly payment to the lender is only $200,
while the loan interest rate is 5%). In this situation, negative amortization occurs. What will be the
accrued interest or the amount of increased loan balancefor the loan three years later from now?
[3pts]
Answer Refer Excel Sheet Tab- Answer 5
(d) Assume that Luis has to borrow two loans in order to refinance. That is, he has to borrow a new
mortgage ($70,000) at 5% for 10 years (i.e., the loan maturity and the amortization period are the
same, 10 years) and another mortgage ($22,895) at 9% for 5 years (the loan maturity and the

amortization period are the same, 5 years). In this case, with the same origination fee of $3,000
and the prepayment penalty of 3%, should Luis go ahead with the refinancing plan? Please show
the step to support your answer? [5 pts]
Answers
Refer Excel Sheet Tab- Answer 5

You might also like