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Running head: QUESTION-ANSWER ESSAY 1

Question-Answer Essay

Student’s Name

Institution Affiliation

QUESTION-ANSWER ESSAY 2

Question-Answer Essay

Question One

Third party financial assistance is necessary during construction when the borrower is

expecting a permanent loan soon, but it requires urgent cash flow to accomplish a financial

obligation or when the amount is not sufficient to complete the project. The financing gap loan is

usually short-term, meaning high-interest rates due to the risk associated. Using the personal

property as collateral to secure such a loan is sometimes necessary.

Question Two

An option contract is an agreement that gives the buyer the privilege to buy a commodity

or property at an agreed price in the future. In a land acquisition, the buyer and seller enter into

an agreement that allows the former to purchase the property within a certain period at the agreed

price after given contingencies have been met (Castro, 2017). The buyer pays an option amount

that is deducted from the purchase price if he/she opts to continue with the transaction, but if

he/she decides not to the amount remains with the seller. Contingencies that may be included in a

land option comprises rezoning request, environmental condition test, time to secure finance to

close the deal or time to obtain a permit for a particular development.

Question Three

The secondary mortgage market is a platform that allows the lender of mortgages such as

the bank and other primary lending institutes to resale loans to investors such as the federal

government to regain their financial status (Faltin-Traeger, Johnson, & Mayer, 2010). The

secondary mortgage market is important because of the following:

QUESTION-ANSWER ESSAY 3

a. It allows the primary-funding institutes to regain their financial status. The banks after

issuing loans to the borrower reduce their resource capability and, hence, use the

secondary mortgage market to resell it to regain its capacity to offer more loans.

b. It enhances the geographical flow of funds and, in such way, avails funds to homebuyers

in places where capital is scarce.

c. It brings more options to lenders and individuals. The secondary mortgage market

enables the bank to offer loans at lower interest rates, which increases their options as

lenders.

Question Four

Part a: major classes

The following are the main classes of mortgage-related securities:

a. Mortgage pass through security (MPTs)

b. Collateralized mortgage obligation (CMO)

c. Principal-only securities (POs)

d. Interest-only securities (IOs)

Part b: Reasons for selection of a particular mortgage security

The issuer has to decide the type of mortgage security carefully to select depending on

the level of risk and payment methods.

MPTS extends the secondary market mortgage but has limitations: the cash flow to

investors depends on the prepayments ability of the borrower, and it often fluctuates. CMO

counters these shortcomings by offering a steady flow of cash from a pool MPTS creates and

from a mortgage loan as collateral; hence, more security is provided (Collin-Dufresne, Goldstein,

& Yang, 2012). CMO constitutes the creation of tranches which have definite dates of payment,

QUESTION-ANSWER ESSAY 4

and the investor knows the dates to receive the last payment. Consequently, it would be easy for

the issuer to plan for another investment project.

Another category of mortgage securities depends on the prepayment type. For instance,

the market value of the POs is profoundly affected by the rate of prepayments, i.e., when the

rates of prepayment increases, so do their value in the market. By contrast, the IOs value

increases when the prepayments value is low, but the investors take the risk of receiving fewer

amounts when the rates of prepayments are higher.

QUESTION-ANSWER ESSAY 5

References

Castro, D. I. (2017). Collateralized debt obligations (CDOs). In D. I. Castro (Ed.), Capital

Markets: Evolution of the Financial Ecosystem (pp. 361–380). Hoboken,NJ: John Wiley &

Sons. https://doi.org/10.1002/9781119220589.ch21

Collin-Dufresne, P., Goldstein, R. S., & Yang, F. (2012). On the relative pricing of long-maturity

index options and collateralized debt obligations. Journal of Finance, 67(6), 1983–2014.

https://doi.org/10.1111/j.1540-6261.2012.01779.x

Faltin-Traeger, O., Johnson, K. W., & Mayer, C. (2010). Issuer credit quality and the price of

asset backed securities. American Economic Review, vol. 100, 501–505.

https://doi.org/10.1257/aer.100.2.501

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