UCLA ECON 103 - Chap004 (1) (21 pages)

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Chap004 (1)



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Chap004 (1)

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Pages:
21
School:
University of California, Los Angeles
Course:
Econ 103 - Introduction to Econometrics

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Chapter 04 Fixed Interest Rate Mortgage Loans Solutions to Questions Chapter 4 Fixed Interest Rate Mortgage Loans Question 4 1 What are the major differences between the CAM and CPM loans What are the advantages to borrowers and risks to lenders for each What elements do each of the loans have in common CAM Constant Amortization Mortgage Payments on constant amortization mortgages are determined first by computing a constant amount of each monthly payment to be applied to principal Interest is then computed on the monthly loan balance and added to the monthly amount of amortization to determine the total monthly payment CPM Constant Payment Mortgage This payment pattern simply means that a level or constant monthly payment is calculated on an original loan amount at a fixed rate of interest for a given term CAM lenders recognized that in a growing economy borrowers could partially repay the loan over time as opposed to reducing the loan balance in fixed monthly amounts CPM At the end of the term of the mortgage loan the original loan amount or principal is completely repaid and the lender has earned a fixed rate of interest on the monthly loan balance However the amount of amortization varies each month When both loans are originated at the same rate of interest the yield to the lender will be the same regardless of when the loans are repaid i e early or at maturity Question 4 2 Define amortization Amortization is rate at which the process of loan repayment occurs over the loan term Types of amortization are fully partially zero negative and constant rates of amortization Question 4 3 Why do the monthly payments in the beginning months of a CPM loan contain a higher proportion of interest than principal repayment The reason for such a high interest component in each monthly payment is that the lender earns an annual percentage return on the outstanding monthly loan balance Because the loan is being repaid over a long period of time the loan balance is reduced only



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