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1

Many investors in income-producing properties, such as apartment buildings, find it financially advantageous to borrow a part of the required capital even though their own funds might be sufficient.

LIST 4 ADVANTAGES OF BORROWING?

First, to diversify investments and reduce the overall portfolio risk,

 

Second, it may be possible to borrow at an interest rate lower than the expected debt free return from the property.

 

Third, debt financing may allow the purchase of real estate as a hedge against inflation.  The investor may anticipate an inflationary rise in the general price level and in the returns on real estate.  If the payments on the loan are fixed for the term of the loan, the investor could expect to pay off the debt in "cheaper" (inflated) dollars

 

A fourth rationale for the use of debt financing is to save (or release) equity for other activities.For example, a merchandising or manufacturing concern may prefer to use available funds in the business (i.e., for inventory or expansion) rather than to invest it in land and buildings.

2

What are three disadvantages of mortgages as investments?

  1. heavy administrative burden
  2. lack of a secondary market
  3. illiquid investment
  4. requires large capital requirements

3

What is financial leverage?

Financial leverage refers to the use of debt to acquire additional assets.

4

Explain how real estate may be used as a hedge against inflation?

If the payments on the loan are fixed for the term of the loan, the investor may pay off the debt in “cheaper” (inflated) dollars.

5

During this period, mortgage financing involved long-term loans where interest was paid periodically (generally monthly) throughout the life of the loan. Partial payments of principal seldom occurred; rather the entire principal amount was repaid (or refinanced) at the end of the loan term.

ANSWER:  1900 to Late 1920s

6

During the economic collapse of the Depression (in the 1930s), many borrowers were forced to live off their savings rather than pay off a mortgage when due. Consequently, many lenders found they were owed the full amount of principal outstanding on a large number of loans by individuals without any funds, whose property was worthless as security. Lenders and borrowers suddenly became aware of the ________ risk associated with interest only loans.

ANSWER:  PRINCIPAL RISK

7

How did the mortgage market respond to the great depression?  Eg.  what change resulted from the depression?

The market responded to the depression by turning to the use of repayment plans where periodic payment of both interest and principal occurred. The most common form of these repayment plans was the long-term, fully amortized mortgage, where each payment was constant in amount and was comprised of interest due, plus a partial repayment of principal. 

8

A major innovation during this period was the use of mortgage default insurance. 

ANSWER:  

Post World-War II Period

9

NOTE ONLY

 

To increase the supply of mortgage money, the federal government tried to encourage financial institutions to increase their participation in mortgage lending by reducing the risk of loss in the event of default. The most successful method (which is still used) took the form of government insurance against default on residential mortgage loans granted under the terms of the National Housing Act.

NOTE ONLY

 

To increase the supply of mortgage money, the federal government tried to encourage financial institutions to increase their participation in mortgage lending by reducing the risk of loss in the event of default. The most successful method (which is still used) took the form of government insurance against default on residential mortgage loans granted under the terms of the National Housing Act.

10

NOTE ONLY

 

PARTIALLY AMORTIZED MORTGAGES

 

By the end of the 1960s, there was rapid inflation as well as rising consumer demands. The increase in consumer demand also increased competition between investment and consumption demands for the money supply.

 

Consequently, in order to ration funds, interest rates rose significantly and long-term lenders found themselves forced with a new type of risk—interest rate risk.

 

Mortgage lenders had no protection from being locked into long-term loans at rates below the current rate. Individual borrowers  were protected, to some extent, from holding long-term debt at rates above the going rate because they were allowed to prepay the loan (paying an interest penalty) under Section 10 of the federal Interest Act.

 

From the lenders’ viewpoint, the opportunity cost of a heavy commitment to long-term fixed rate assets was first illustrated by the 31% (9% to 11.8%) increase in conventional mortgage interest rates in the three-year period commencing in January of 1972. Given the 72% increase that occurred between September 1979 and September 1981, from 12.5% to 21.46%, the 1972 increase does not seem significant, but, in its time, this first jump was of great concern to holders of fixed rate, long-term debt instruments. 


In these circumstances, the mortgage agreement needed to be altered to give both borrowers and lenders increased protection against interest rate fluctuations.

 

The result of this need for protection was the emergence of the partially amortized mortgage, which has periodic payments based on a long-term fully amortized loan, but which matures on a short-term basis. At maturity, the full amount of the outstanding balance must be repaid or refinanced at the market interest rate.

 

This feature permits both lenders and borrowers to share the risk of possible fluctuations in the long-term lending rate.

NOTE ONLY

 

PARTIALLY AMORTIZED MORTGAGES

 

By the end of the 1960s, there was rapid inflation as well as rising consumer demands. The increase in consumer demand also increased competition between investment and consumption demands for the money supply.

 

Consequently, in order to ration funds, interest rates rose significantly and long-term lenders found themselves forced with a new type of risk—interest rate risk.

 

Mortgage lenders had no protection from being locked into long-term loans at rates below the current rate. Individual borrowers  were protected, to some extent, from holding long-term debt at rates above the going rate because they were allowed to prepay the loan (paying an interest penalty) under Section 10 of the federal Interest Act.

 

From the lenders’ viewpoint, the opportunity cost of a heavy commitment to long-term fixed rate assets was first illustrated by the 31% (9% to 11.8%) increase in conventional mortgage interest rates in the three-year period commencing in January of 1972. Given the 72% increase that occurred between September 1979 and September 1981, from 12.5% to 21.46%, the 1972 increase does not seem significant, but, in its time, this first jump was of great concern to holders of fixed rate, long-term debt instruments. 


In these circumstances, the mortgage agreement needed to be altered to give both borrowers and lenders increased protection against interest rate fluctuations.

 

The result of this need for protection was the emergence of the partially amortized mortgage, which has periodic payments based on a long-term fully amortized loan, but which matures on a short-term basis. At maturity, the full amount of the outstanding balance must be repaid or refinanced at the market interest rate.

 

This feature permits both lenders and borrowers to share the risk of possible fluctuations in the long-term lending rate.

11

The ____________ permits individuals to make a tax-free withdrawal from their Registered Retirement Savings Plan (RRSP) to purchase or build a home, on the condition that the amount withdrawn is repaid in full within 15 years.

The Home Buyers’ Plan (HBP) permits individuals to make a tax-free withdrawal from their Registered Retirement Savings Plan (RRSP) to purchase or build a home, on the condition that the amount withdrawn is repaid in full within 15 years.

12

As an attempt to reduce INTEREST RATE RISKS FOR BORROWERS, the federal government introduced an _ _ _ _ _ _ _ _  program in 1984. 

As an attempt to reduce INTEREST RATE RISKS FOR BORROWERS, the federal government introduced an interest rate insurance program in 1984. 

13

In the 1980s the federal government also took steps to stabilize the flow of mortgage funds by attempt-ing to attract more investors to the mortgage market. In 1986, Canada Mortgage and Housing Corporation (CMHC) created a new financial instrument called _ _ _ _ _ _ _ _ _ _ which are designed to help provide a steady flow of mortgage funds into housing in Canada.

The federal government also took steps to stabilize the flow of mortgage funds by attempt-ing to attract more investors to the mortgage market. In 1986, Canada Mortgage and Housing Corporation (CMHC) created a new financial instrument called NHA Mortgage-Backed Securities (MBS) which are designed to help provide a steady flow of mortgage funds into housing in Canada.

14

A significant change to mortgage financing in the 1990s was the introduction of _ _ _ _ _ _ _ _ _

A significant change to mortgage financing in the 1990s was the introduction of the 95% loan-to-value ratio.

15

Explain the Canadian Mortgage Bond (CMB) program?

Under the CMB program, the Canada Housing Trust (CHT), a special purpose trust created and managed by CMHC, issues CMBs to investors and uses the proceeds to purchase NHA mortgage-backed securities.

 

Under a CHT, investors purchase the bonds and receive fixed-interest payments every six months. These payments are guaranteed by the CMHC, as all the underlying mortgages are CMHC-insured. This reduces the risk associated with the bond, making them an attractive and conservative investment.

 

The proceeds received from the sale of the bonds are then used to purchase mortgage-backed securi-ties. The proceeds from the underlying mortgages of the mortgage-backed securities are used to pay the principal and interest payments to the bondholders.

 

The initial goals of the program were to promote competition in the residential mortgage market and to provide lower cost mortgage funding to financial institutions

16

What are Prime Mortgages?

Prime mortgages also known as “A” mortgages

 

Represent the majority of mortgage lending in Canada.

 

Mortgage that deal with borrowers who can qualify for mortgages based on their credit score and/or gross income.

 

Less risky for banks

17

In general, the longer the term of an investment, the higher the rate of interest that must be paid to lock in investment funds unless _ _ _ _ _ _ _ _.

In general, the longer the term of an investment, the higher the rate of interest that must be paid to lock in investment funds unless there is a general expectation of declines in interest rates in the future.

18

What is a Sub-Prime Motgage?

Subprime Mortgages

A subprime mortgage (also referred to as nonprime, near-prime, nonconforming, or high-risk) is a mortgage that is granted to a loan candidate who is considered to be high-risk, due to one or a combination of:

 

poor or limited credit rating;

non-veriable income;

a previous consumer proposal; and

a bankruptcy.

19

Explain the differences between the Canadian and American sub-prime market?

Differences between US and Canadian Subprime Market

 

Canadian mortgage lenders are generally more conservative than their American counterparts. All high-ratio Canadian mortgages must be secured with mortgage insurance and Canadian financial institutions do not lend more than 100% of the purchase price. However, risks do exist in the Canadian market.

 

Declines in Canadian housing prices and increases in interest rates could lead to problems for borrowers. Overall, the risks are lower in Canada since there are fewer subprime loans, tighter restrictions on borrowing, and fewer mortgages at floating rates. Only 22% of subprime mortgages in Canada in 2007 used variable rate mortgages, which is half the ratio of the United States.

 

In addition, since mortgage interest is tax deductible on US principal residences, some Americans have been more inclined to obtain a mortgage loan.

20

The financial markets in Canada are generally characterized as consisting of a ________ and a ________.

The financial markets in Canada are generally characterized as consisting of a MONEY MARKET and a CAPITAL MARKET.

21

The money market is described as a national market specializing in the buying and selling of _ _ _ _ _ _ _ _ _ _ _

The money market is described as national market specializing in the buying and selling of short-term credit.

22

As a general consideration, the money market is generally limited to the creation, purchase and sale of credit notes with less than a three-year maturity.

 

This market includes. . .[LIST 5 Money Market Instruments] 

As a general consideration, the money market is generally limited to the creation, purchase and sale of credit notes with less than a three-year maturity. This market includes:

 

Government of Canada short-term bonds and treasury bills

 

Day-to-day loans through banks

 

Commercial paper: short-term negotiable notes issued by private corporations which call for the payment of a specific amount of money at some specified future date

 

Banker’s acceptances: short-term bank notes

 

Trust company guaranteed investment certificates: short-term credit notes issued by trust companies

23

What are three disadvantages of mortgages as investments?

  1. heavy administrative burden
  2. lack of a secondary market
  3. illiquid investment
  4. requires large capital requirements

24

TRUE OR FALSE?

A mortgage is more liquid than a government bond?

ANSWER:  FALSE

25

List 5 types of investments traded in capital markets . . .

 

ANSWER:

 

Long-term credit notes INCLUDING Bonds, 

Debentures and Mortgages

 

Equity issues, either common stock or preferred shares

26

What are the four functions of the Bank of Canada?

The Bank of Canada has four principal functions:

1. Issuing currency: The Bank of Canada has a monopoly over the right to issue all notes for circulation in Canada.

 

2. Acting as a banker to the commercial banks: This role includes managing the payments from one commercial bank to another, as well as making short-term daily loans to the banks. The Bank also acts as a lender of last resort to the commercial banks: if a commercial bank is in trouble and has no other sources to borrow money from, the Bank will lend them money to ensure stability in Canada’s financial system.

 

3. Acting as a banker to the Canadian government: The Bank manages the government’s bank accounts, as well as Canada’s foreign exchange reserves and national debt on behalf of the government.

 

4. Control the money supply: The Bank of Canada manages the quantity of money that is available to the economy.

27

One of the main tools used by the Bank of Canada to conduct monetary policy is known as the _ _ _ _ _ _ _ _. This is the interest rate charged by the Bank of Canada on one-day loans to financial institutions, including commercial banks.

One of the main tools used by the Bank of Canada to conduct monetary policy is known as the BANK RATE. This is the interest rate charged by the Bank of Canada on one-day loans to financial institutions, including commercial banks.

28

In general, the longer the term of an investment, the ______ the rate of interest that must be paid to lock in investment funds.

In general, the longer the term of an investment, the HIGHER the rate of interest that must be paid to lock in investment funds.

29

From the lender’s viewpoint, the interest rate charged on a mortgage loan is comprised of three components:

From the lender’s viewpoint, the interest rate charged on a mortgage loan is comprised of three components:

 

The return on the invested capital determined by prevailing rates in investment markets and by the supply of and demand for mortgage investment funds.

 

An inducement to accept risk on the capital resulting from an uncertain investment; prime investments will generally be granted a lower rate than investments involving greater risks, i.e., junior mortgages.

 

Payment to the lender of a proportion of the general capital and operating costs of mortgage lending activities.

30

List the four characteristics of mortgage loans as investments?

Illiquidity

Long repayment term

High administrative burden

Large capital investment

31

Many investors in income-producing properties, such as apartment buildings, find it financially advantageous to borrow a part of the required capital even though their own funds might be sufficient.

LIST 4 ADVANTAGES OF BORROWING?

First, to diversify investments and reduce the overall portfolio risk,

 

Second, it may be possible to borrow at an interest rate lower than the expected debt free return from the property.

 

Third, debt financing may allow the purchase of real estate as a hedge against inflation.  The investor may anticipate an inflationary rise in the general price level and in the returns on real estate.  If the payments on the loan are fixed for the term of the loan, the investor could expect to pay off the debt in "cheaper" (inflated) dollars

 

A fourth rationale for the use of debt financing is to save (or release) equity for other activities.For example, a merchandising or manufacturing concern may prefer to use available funds in the business (i.e., for inventory or expansion) rather than to invest it in land and buildings.

32

TRUE OR FALSE?  Financial leverage involves the use of debt to possibly increase yield.

ANSWER:  TRUE

33

Explain two factors which can affect the supply of mortgage funds?

  1. Changes in the level of savings
  2. Changes in monetary policy
  3. Changes in fiscal policy
  4. Changes in government policy

34

What are three disadvantages of mortgages as investments?

  1. heavy administrative burden
  2. lack of a secondary market
  3. illiquid investment
  4. requires large capital requirements

35

TRUE OR FALSE?
A mortgage is easy to trade?

ANSWER: FALSE

36

TRUE OR FALSE?

Government bonds are generally regarded as a safe, risk free investment.

 

ANSWER:  TRUE

37

NOTE ONLY / GOVT BONDS

 

A federal government bond represents a promise by the Canadian Government to pay the interest stated and to repay the capital at the stated date. Therefore, the holder of the bond has little to worry about in terms of income security as the government is not likely to default on either payment of interest or repayment of principal.

 

The only risks are from general price fluctuations before the date of redemption and the possibility of a fall in the value of money. In these relatively riskless circumstances, the rate of interest is relatively low.

NOTE ONLY / GOVT BONDS

 

A federal government bond represents a promise by the Canadian Government to pay the interest stated and to repay the capital at the stated date. Therefore, the holder of the bond has little to worry about in terms of income security as the government is not likely to default on either payment of interest or repayment of principal.

 

The only risks are from general price fluctuations before the date of redemption and the possibility of a fall in the value of money. In these relatively riskless circumstances, the rate of interest is relatively low.

38

NOTE ONLY / BONDS VS. MORTGAGES

 

In comparision to government bond, a mortgage lender does not enjoy the same degree of security. The promise of an individual purchasing a house to pay the interest and principal cannot be compared with that of the Canadian Government, and the mortgagee (mortgage lender) may have more trouble in recovering his or her capital than a bondholder.

 

Furthermore, a mortgage is a less liquid investment than a government bond and may require significantly greater management effort. Invested funds that can be easily and quickly converted to cash without loss of capital are considered liquid.


As a compensation for the extra risks and effort involved, the mortgage lender requires a higher expected yield on the loan than is obtainable from a government bond. Generally, the rate on a well-secured first mortgage will be greater than the yield on government bonds redeemable at the end of a time period similar to that of the term of the mortgage.

 

NOTE ONLY / BONDS VS. MORTGAGES

 

In comparision to government bond, a mortgage lender does not enjoy the same degree of security. The promise of an individual purchasing a house to pay the interest and principal cannot be compared with that of the Canadian Government, and the mortgagee (mortgage lender) may have more trouble in recovering his or her capital than a bondholder.

 

Furthermore, a mortgage is a less liquid investment than a government bond and may require significantly greater management effort. Invested funds that can be easily and quickly converted to cash without loss of capital are considered liquid.


As a compensation for the extra risks and effort involved, the mortgage lender requires a higher expected yield on the loan than is obtainable from a government bond. Generally, the rate on a well-secured first mortgage will be greater than the yield on government bonds redeemable at the end of a time period similar to that of the term of the mortgage.

39

Many investors in income-producing properties, such as apartment buildings, find it financially advantageous to borrow a part of the required capital even though their own funds might be sufficient.

 

LIST 4 ADVANTAGES OF BORROWING?

First, to diversify investments and reduce the overall portfolio risk,

 

Second, it may be possible to borrow at an interest rate lower than the expected debt free return from the property.

 

Third, debt financing may allow the purchase of real estate as a hedge against inflation.  The investor may anticipate an inflationary rise in the general price level and in the returns on real estate.  If the payments on the loan are fixed for the term of the loan, the investor could expect to pay off the debt in "cheaper" (inflated) dollars

 

A fourth rationale for the use of debt financing is to save (or release) equity for other activities.For example, a merchandising or manufacturing concern may prefer to use available funds in the business (i.e., for inventory or expansion) rather than to invest it in land and buildings.

40

The economic collapse during the Depression in the 1930s greatly altered lenders' and borrowers' perceptions of risks involved in mortgage lending.

What change in mortgage lending resulted from the Great Depression?

After the Depression, repayment plans of both interest and principal

 

Principal repayment no longer deferred until the maturity date

 

The most common form of these repayment plans was the long-term, fully amortized mortgage

41

TRUE OR FALSE?

Relative to many other investment vehicles, mortgage lending necessitates a heavy administrative burden

ANSWER:  TRUE

42

TRUE OR FALSE?

Mortgage lenders require large amounts of capital 

ANSWER:  TRUE

43

Give 3 examples of money market instruments?

  1. Treasury bills
  2. Commercial paper
  3. GICs
  4. Banker Acceptances

44

NOTE ONLY

1970s: AFFORDABLE HOUSING POLICIES

 

The 1969 Report of the Task Force on Housing and Urban Development (Hellyer Report) suggested a shift in direction in the federal government’s housing and mortgage lending policies.

 

The recommendations emphasized the notion that decent and affordable housing was a fundamental right for all Canadians. Because of the Hellyer Report and other similar studies made public at about the same time, a shift in policy and emphasis occurred in the mortgage market in Canada.

 

This new policy direction emphasized social housing, housing for select groups in society (seniors, low income individuals, and disabled individuals), and affordability.

NOTE ONLY

1970s: AFFORDABLE HOUSING POLICIES

The 1969 Report of the Task Force on Housing and Urban Development (Hellyer Report) suggested a shift in direction in the federal government’s housing and mortgage lending policies. 

 

The recommendations emphasized the notion that decent and affordable housing was a fundamental right for all Canadians. Because of the Hellyer Report and other similar studies made public at about the same time, a shift in policy and emphasis occurred in the mortgage market in Canada. 

 

This new policy direction emphasized social housing, housing for select groups in society (seniors, low income individuals, and disabled individuals), and affordability.