MACROECONOMICS
14th Edition
ISBN: 9781337794985
Author: Baumol
Publisher: CENGAGE L
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Question
Chapter 14, Problem 1TY
To determine
To evaluate: The interest rate on the mortgage-backed security.
Expert Solution & Answer
Answer to Problem 1TY
The interest rate on a mortgage-backed security is higher than the treasury securities.
Explanation of Solution
With the help of given information, it is clear that the expected default rate on a mortgage-backed security is 4% per year and the corresponding Treasury Security annual interest rate is 3%. Investments in houses or securities depend on the interest rate. If the home mortgage interest rates are less, then the prices of the houses will increase. Therefore, as the purchase of houses is more profitable, investors would prefer doing it then investing in the securities. So, here, in this case, the interest rate on a mortgage-backed security is higher than the treasury securities and is a suitable situation to encourage investment in houses.
Further, if the expected default rate is 8% then the house prices will fall as people won’t be in a position to invest in the purchase of houses. A higher interest rate on a home loan will not attract the customers.
A low mortgage interest rate will always increase house prices.
Economics Concept Introduction
Introduction:
Mortgage-backed security: A mortgage-backed security is supposed to be an investment similar to a bond. The only difference is that this represents a bunch of home loans taken from a bank.
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Students have asked these similar questions
Why are bond prices and interest rates inversely related?
The following are data on the Treasury yield curve for July 17, 2012:
Time to maturity
Interest rate
6 months
0.15%
1 year
0.18%
2 years
0.25%
5 years
0.62%
10 years
1.53%
30 years
2.59%
Source: U.S. Department of the Treasury, "Daily Treasury Yield Curve Rates," July 17, 2012.
Given these data, why would an investor have been willing to buy a one-year Treasury bill with an interest rate of only 0.18% when the investor could have bought a
30-year Treasury bond with an interest rate of 2.59%?
O A. An investor would expect interest rates on short-term bonds to be higher in the future.
O B. Investors are exposed to greater interest-rate risk when they buy long-term bonds versus buying short-term bonds.
OC. Most investors have a life expectancy for investing purposes of less than 30 years.
O D. A andB only.
O E. All of the above.
Suppose everyone expects investment to rise sharply in three months. How would this expectation be likely to affect bond prices?
Knowledge Booster
Similar questions
- An FI has purchased a $201 million cap of 8 percent at a premium of 0.70 percent of face value. A $201 million floor of 4.1 percent is also available at a premium of .75 percent of face value. a. If interest rates rise to 9 percent, what is the amount received by the FI? What are the net savings after deducting the premium? b. If the Fl also purchases a floor, what are the net savings if interest rates rise to 10 percent? What are the net savings if interest rates fall to 3.1 percent? (Negative amounts should be indicated by a minus sign.) c. If, instead, the Fl sells (writes) the floor, what are the net savings if interest rates rise to 10 percent? What if they fall to 3.1 percent? (Negative amounts should be indicated by a minus sign.) a. Amount received Net savings b. Net savings if interest rates rise to 10 percent Net savings if interest rates fall to 3.1 percent c. Net savings if interest rates rise to 10 percent Net savings if they fall to 3.1 percentarrow_forwardprove that bond yields and bond prices are inversely related?arrow_forward: Show graphically the effect of a rise in expected inflation on interest rates in the bond market.arrow_forward
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