Question: You must choose between two loans: A and B. A is a fixed rate loan at 4% (compounded semi-annually) for a term of five years,

You must choose between two loans: A and B. A is a fixed rate loan at 4% (compounded semi-annually) for a term of five years, with 20 year amortization and monthly payments. Prepayment is forbidden. Loan B is a fixed rate loan with a term of five years and is prepayable without penalty. The rate on Loan B is 4.5%. You believe that immediately after loan closing (before any payments are made), interest rates will either rise to 6% or fall to 4.4%, each with equal probability. All the other terms of A and B are identical. Would you prefer loan A or loan B?

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