Chapter 10 The Mortgage Markets and Derivatives

The Mortgage
Markets and
Derivatives
Presented By: Dela Pena, Kena
Mimbisa, Raihanisah
MORTGAGE
MARKETS
where borrowers –
individual businesses and
governments can obtain
long-term collaterized
loans.
From one perspective, the mortgage markets form a
subcategory of the capital markets because
mortgages involve long-term funds. But the
mortgage markets differ from the stock and bond
markets in a number of ways.
01 | the usual borrowers in the capital markets are businesses and

government entities, whereas the usual borrowers in the
mortgage markets are individuals.
02 | mortgage loans are made for varying amounts and maturities,

depending on the borrowers’ needs, features that cause
problems for developing a secondary market.
What are
Mortgages?
are long-term loan secured by
real estate. Both individuals and
businesses obtain mortgages
loans to finance real estate
purchases.
CHARACTERISTICS OF THE
RESIDENTIAL MORTGAGE
A | Mortgage Interest Rates
One of the most important factors in the decision

of the borrower of how much and from whom to
borrow is the interest rate on the loan.
There are three important factors that affect the

interest rate on the loan.
Three Important Factors
1. Current long-term market rates

2. Term or Life of the Mortgage
3. Number of Discount Points Paid
B | Loan Terms
Mortgage loan contracts contain many legal and
financial terms, most of which protect the lender
from financial loss.
C | Collateral
One characteristic common to mortgage loans is
the requirement that collateral, usually the real
estate being financed, be pledged as security.
D | Down Payment
A sum a buyer pays upfront when purchasing an
expensive good such as a home or car. It
represents a percentage of the total purchase
price, and the balance is usually financed.
E | Private Mortgage Insurance (PMI)

An insurance policy that guarantees to make up
any discrepancy between the value of the
property and the loan amount, should a default
occur.
F | Borrower Qualification
Before granting a mortgage loan, the lender will
determine whether the borrower qualifies for it.
AMORTIZATION OF
MOTGAGE LOAN
Mortgage Loan borrowers generally agree to
pay monthly amount of principal and interest
that will be fully amortized by its maturity.
“Fully amortized” means that the payments will

pay off the outstanding indebtedness by the
time the loan matures.
Amortization of a 30-Year, P130,000 loan at 8.5%
Payment Beginning Monthly Amount Amount Ending
Number Balance of Payment Applied to Applied to Balance of
Loan Interest Principal Loan
1 130,000.00 999.59 920.83 78.75 129,921.24

24 128,040.25 999.59 906.95 92.66 127,947.62
60 124,256.74 999.59 880.15 119.43 124,137.31
120 115,365.63 999.59 817.17 182.41 115,183.22
180 101,786.23 999.59 720.99 278.60 101,507.63
240 81,046.41 999.59 574.08 425.51 80,620.90
360 991.77 999.59 7.82 991.77 0
Total P359,852 P229,852 P130,000
Types of Mortgages
■ Conventional Mortgages
■ Insured Mortgages
■ Fixed-rate Mortgages
■ Adjustable-Rate Mortgages (ARMs)
■ Graduated-Payment Mortgages (GPMs)

Types of Mortgages
■ Growing Equity Mortgage (GEMs)
■ Shared Appreciation Mortgages (SAMs)
■ Equity Participating Mortgage (EPM)
■ Second Mortgages
■ Reverse Annuity Mortgages (RAMs)

Securization of Mortgages
Intermediaries face several problems when trying to sell mortgages to
the secondary market; that is lenders selling the loans to another
investor. These problems are
a) Mortgages are usually too small to be wholesale instruments

b) Mortgages are not standardized. They have different terms to maturity,
interest rates and contract terms. Thus, it is difficult to bundle
a large number of mortgages together and
c) Mortgages have unknown default at risk. Investors in

mortgages do not want to spend a lot of time and effort in
evaluating the credit of borrowers.
The above problems inspired
the creation of:
Mortgage-backed security is a security
that is collaterized by a pool of mortgage
loans.
Securitization is the process of

transforming illiquid financial assets into
marketable capital market instruments.
Impact of Securitized Mortgage
on the Mortgage Market
Mortgage-backed securities (also called securitized mortgages)
have been growing in popularity in recent years as institutional
investors look for appreciative investment opportunities that
compete for funds with government notes bonds, corporate bonds
and stock.
Securitized Mortgage are low-risk securities that have

higher yield than comparable government bond and
attract funds from around the world.
Derivatives Financial
Instrument
Derivatives are financial instruments that

“derive” their value on contractually required
cash flows from some other security or index.
Characteristics of Derivatives
A derivative is a financial instrument:
a) whose value changes in response to the change in a specified interest rate,

security price, commodity price, foreign exchange rate, index of prices or
rates, credit rating or credit index, or similar variable (sometimes called the
“underlying”);
b) that requires no initial net investment or little net investment relative to
other types of contracts that have a similar response to changes in market
conditions; and
c) that is settled at a future date.
How it Works?
Investors may buy derivatives in order to reduce the amount
of volatility in their portfolios, since they can agree on a price
for a deal in the present that will, in effect, happen in the
future, or to try to increase their gains through speculation.
Derivatives can enable an investor to gain exposure to a
market via a smaller outlay than if they bought the actual
underlying asset. The most common are futures and options
– leveraged products in which the investor puts down a
small proportion of the value of the underlying asset and
hopes to gain by a future rise in the value of that asset.
Derivatives for Hedging
Companies use derivatives to protect against cost

fluctuations by fixing a price for a future deal in
advance. By settling costs in this way, buyers gain
protection – known as a hedge – against unexpected
rises or falls in, for example, the foreign exchange
market, interest rates, or the value of the commodity
or product they are buying.
Derivatives for Speculation
Investors may buy or sell an asset in the hope of

generating a profit from the asset’s price
fluctuations. Usually this is done on a short-term
basis in assets that are liquid or easily traded.
Examples of Derivatives
■ Future Contract
■ Forward Contract
■ Options
■ Foreign Currency Futures
■ Interest Rate Swaps

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Yaurrrrrrrr!
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The Mortgage

01 | the usual borrowers in the capital markets are businesses and

02 | mortgage loans are made for varying amounts and maturities,

A | Mortgage Interest Rates

One of the most important factors in the decision

There are three important factors that affect the

1. Current long-term market rates

E | Private Mortgage Insurance (PMI)

“Fully amortized” means that the payments will

1 130,000.00 999.59 920.83 78.75 129,921.24

■ Adjustable-Rate Mortgages (ARMs)

■ Graduated-Payment Mortgages (GPMs)

■ Shared Appreciation Mortgages (SAMs)

■ Equity Participating Mortgage (EPM)

■ Reverse Annuity Mortgages (RAMs)

a) Mortgages are usually too small to be wholesale instruments

c) Mortgages have unknown default at risk. Investors in

Securitization is the process of

Securitized Mortgage are low-risk securities that have

Derivatives are financial instruments that

A derivative is a financial instrument:

a) whose value changes in response to the change in a specified interest rate,

Companies use derivatives to protect against cost

Investors may buy or sell an asset in the hope of

■ Foreign Currency Futures

■ Interest Rate Swaps

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