# Consider a construction loan made to Middleton Development Co.

1. 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?

Month

Draws

Interest

Carry

Cumulative

Loan Bal.

1

2

3

4

5

6

Total

2. A multifamily property is expected to produce the following income

stream over the next three years:

Year

NOI

1

$575,000

2

600,000

3

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 gets10% 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-tax mortgage yield for the loan, assuming

that the loan is held for 3 years. (5 pts)

b)

What is lender’s 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)

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. (5 pts)

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 plansto buythe house at a price of$300,000. Hewants to borrow a 80% loan to purchase the home.You

tell himthat 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? [3 pts]

(b)What

is the effective interest rate,assuming the mortgage is paid off after 30

years? [3 pts]

(c) If the borrower plans to repay the loan afterthreeyears, what is the effective interest

rate? [3 pts]

(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? [3 pts]

(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. [3 pts]

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.

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 that the 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

2

3

4

Return

=

—

b.)

Year

CF from

the pool

Senior

Class

Subordinated

Class

Residual

Class

1

2

3

4

Return =

—

4. Bank of America issues a MBS

security based on a mortgage pool with the following terms:

Mortgage pool value $25,000,000

Mortgage interest rate 6.5%

Loan Term 3 years

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. (5 pts)

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%.(5 pts)

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. (5 pts)

5.

Luistook a mortgage

loan 5 years ago for $120,000 at 7% interest for15 years, to be

paid in monthly payments. Now,a

lender is offering hima new mortgage loan at 5% for10 years.

The new loan amount

is $92,895, the outstanding loan balance of the existing loan. Suppose that a

prepayment penalty of3

% must be paidif 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 for10 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) Whatisthetotal financingcost (not include the loan amount itself)if Luis decides

to refinancetheoldloan?

[2 pts]

(b) Given the information provided here, should Luis refinance?

Please support your

answer by calculating the effective interest rate of the new loan. [5 pts]

(c) Now suppose

that Luis’s 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 balance for

the loan three years later from now? [3 pts]

(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]

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