1.

Explain what mortgage markets are

Mortgage markets is where the borrowers – individual businesses and governments can obtain
long-term collaterized loans
2. Differentiate between stock and bond markets and mortgage market
The mortgage markets differ from the stock and bond markets in a number of ways. First is the
usual borrowers in the capital markets are businesses and government entities, whereas the usual
borrowers in the mortgage markets are individuals. And then, mortgage loans are made for
varying amounts and maturities, depending on the borrowers’ needs, features that cause problems
for developing a secondary market.
3. Describe what are mortgages
Individuals and businesses obtain mortgages loans to finance real estate purchases. Mortgages are
long-term loan secured by real estate. It uses property or real estate as a collateral.
4. Enumerate and explain the important factors that affect the interest rate on the loan
The three important factors that affect the interest rate on the loan are Current long-term market
rates in which it determined by the supply of and demand for long-term funds, which are in turn
affected by a number of global, national, and regional factors. In this, mortgage rates tend to stay
above the less risky treasury bonds most of the time but tend to track along with them. The
second one is the Term or Life of the mortgage, in general longer-term mortgages have higher
interest rates than short-term mortgages. The usual mortgage lifetime is 15 or 30 years, because
interest rate risk falls as the term to maturity decreases.
5. Distinguish between
a. Conventional mortgages and insured mortgages
Conventional mortgages are originated by banks or other mortgages lenders but are not
guaranteed by the government or government controlled entities while Insured mortgages are
originated by banks or other mortgage lenders but are not guaranteed by either the government or
government-controlled entities.
b. Fixed-rate mortgages and adjustable-rate mortgages
Fixed-rate mortgages’ interest rate and the monthly payment do not vary over the life of the
mortgage while the Adjustable-rate mortgages (ARMs) is tied to some market interest rate, and
therefore changes over time. It usually have limits, called caps, on how high or low the interest
rate can move in one year and during the term of the loan.
c. Graduated-payment mortgages and growing equity mortgages
Graduated-payment mortgages (GPMs) is useful for home buyers who expect their incomes to
rise. It has lower payments in the first few years, then the payments rise. The early payments may
not be even sufficient to cover the interest due, in which case the principal balances increases
while growing equity mortgages (GEMs), the payments will initially be the same as on a
conventional mortgage. However, the payment will increase that will reduce the principal more
quickly than the conventional payment stream would.
6. Describe what derivative financial instruments are
Derivative financial instruments are derivatives that “derive” their value on contractually required
cash flows from some other security or index. For example, a contract allowing a company to
purchase an asset at a designated future date, at a predetermined price is a financial instrument
that derives its value from expected and actual changes in the price of the underlying asset.
7. Distinguish between derivatives for hedging and derivatives for speculation
Derivatives for hedging is used by the company to protect against cost fluctuations by fixing a
price for a future deal in advance. By settling the costs, buyers gain protection – known as hedge
– against unexpected rises or falls in. while derivatives for speculation is used by the investors to
buy or sell asset in the hope of generating a profit from the assets price fluctuations. This is done
on a short-term basis in assets that are liquid or easily traded.
8. Explain briefly the nature of the most frequently used derivatives such as
Future Contracts
A future contract is an agreement between a seller and a buyer that requires the seller to deliver a
particular commodity at a designated future date, at a predetermined price.
Forward Contracts
A future contract is similar to a future contract but differs in three ways; it calls for delivery on a
specific date, whereas a future contract permits the seller to decide, unlike future contract it
usually not traded on a market exchange and it does not call for a daily cash settlement for price
changes in the underlying contract.
Options
Options give its holder the right either to buy or sell an instrument, at a specified price and within
a given time period. Option serves the same purpose as futures in that respect but are
fundamentally different. The option holder has no obligation to exercise the option.
Foreign Currency Futures
Foreign loans frequently are denominated in the currency of the lender. They work the same way
to protect against foreign exchange risk as financial futures protect against fair value or cash flow
risk.
Interest Rate Swaps
Over 70% of derivatives are interest rate swaps. These contracts exchange fixed interest payments
for floating rate payments, or vice versa, without exchanging the underlying principal amounts.
9. Know the financial instruments that meet the characteristics of a derivative together with the
underlying variable affecting the value
A derivative is a financial instrument whose value changes in response to the change in a
specified interest rate, security price, commodity price, foreign exchange rate, index of prices or
rates, credit rating or credit index, or similar variable that is sometimes called the “underlying”.