Question: A basic ARM is made for $500, 000 at an initial interest rate of 3% with 3 discount points for 10 years. Payments are to

A basic ARM is made for $500, 000 at an initial interest rate of 3% with 3 discount points for 10 years. Payments are to be reset each year. The borrower believes that the interest rate at the beginning of year 2 will increase to 9 percent. Assuming that fulling amortizing is made and negative amortization is allowed if payment cap reached. If the ARM loan has a maximum 5% annual increase payment cap, what is the expected yield to the lender if the ARM loan is repaid after two years?

a. 7.53%

b. 6.95%

c. 5.81%

d. 8.42%

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