Consider a $160,000, 20-year ARM with monthly payments and annual interest adjustments. The initial interest rate is 6.5%. The index for the loan is 1-year US Government bonds, currently yielding .4.75%. The loan has a margin of 250 basis points and interest caps of 2% per year at each adjustment and 4% over the life of the loan. It is expected that one-year bond yields will increase to 6.35% over the second year (at the end of Year 1) and to 8% during Year 3 (at the end of Year 2).

(a) Is the loan’s initial interest rate a “teaser rate”? How do you know?

(b) If 1-year T-bonds remain at 5%, what will be the applicable interest rate for this mort- gage after the first year?

(c) What are the initial monthly payments on this loan?

(d) Assuming T-Bonds remain at 5%, what will be the monthly payments after the first year?

(e) Under that assumption (and assuming no discount points), what is the forecasted yield- to-maturity on this loan at the time it is issued.