Reference no: EM132459108

The market value of a leveraged property, say an office building, evolves over time. Both the buyer and the mortgage lender know that the value of the property at any future date will differ from to its price at the date of purchase, but neither party can, with certainty, precisely forecast that value. Consider how the change in the market value of a property is divided between the equity holder and debt holder if the property is sold by the equity holder at a given future date.

a) Assume the equity holder has satisfactorily serviced his mortgage payments since purchase. How are the proceeds of such a sale apportioned or divided between these two claimants?

b) Assume the shareholder fails to service his mortgage payments and the property is foreclosed upon and put up for sale. How are the proceeds apportioned now?

c) Is the possibility of default by the equity owner a net benefit to him? Is the ability to foreclose in the event of a default a net benefit to the lender?

d) If either default or foreclosure is a net benefit to at least one of the two parties, who pays for it and is that payment explicit or embedded implicitly in the terms of the loan? Would the value of the payment differ between these two representations?