Q1

a) Explain why pre-payment risk is more likely when a mortgage is young than when the mortgage is approaching its completion date. [5 marks]

b) Martin has borrowed 250,000 to buy a house. The mortgage rate is 5% per year. How much more will his repayments be per month if he chooses a mortgage term of 15 years instead of 25 years? [10 marks]

c) If Martins required rate of return is 1% per month, which of the two mortgage terms will he choose? (Hint: you could either use a spreadsheet to work out the present value of the cash flows or you could calculate the present value of the corresponding annuities, but remember you are calculating costs to Martin) [10 marks]