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Your broker calls to offer you the investment opportunity of a lifetime, the chance to invest in mortgage backed securities. The broker explains that these securities are entitled to the principal and interest payments received from a pool of residential mortgages. List some of the questions you would ask your broker to assess the risk of this investment opportunity. Questions you would ask include: (Select the best choice below.)
___A. Will borrowers soon be experiencing an interest rate increase because they took out a mortgage with a low initial rate that was adjustable after a period of time? ___B. Percentage of properties in the region that are "under water" (homeowners owe more than they borrowed) or in foreclosure. ___C. Type of real estate (commercial properties offer less liquidity if the market turns sour, because empty homes can be rented for revenue). ___D. Quality of real estate (is it in a good condition, or would there need to be repairs prior to sale?) ___E. What percentage of borrowers are behind on their mortgage payments? ___F. Creditworthiness of borrowers (how likely is it that borrowers will lose their job and be unable to make payments on a timely basis?). ___G. Real estate location (after all, the three most important determinants of real estate price are "location, location, location"). ___H. Precedence in bankruptcy (would other lenders have a senior claim to properties in bankruptcy?).
Calculate the best-case and worst-case NPV figures.
Assumptions and Data: Note that you will need an estimate of the risk-free rate, rRF, and the market risk premium.
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