Suppose you are interested in financing your new home purchase. You have your choice of a myriad financing options. You could enter into any one of the following agreements: 8% fixed rate for 7 years, 8.5% fixed rate for 15 years, 9% fixed for 30 years. In addition, you could finance with a 30-year variable rate that begins at 5% and increases and decreases with the prime rate, or you could finance with a 30-year variable rate that begins at 6% with ceilings of 2% per year to a maximum of 12% and no minimum. a. Suppose you believe that interest rates are on the rise. If you want to completely eliminate your risk of rising interest rates for the longest period of time, which option should you choose? b. Would you consider that hedging or insuring? Why c. What does your risk-management decision “cost” you in terms of quoted interest rates during the first year?
Question:
1. Suppose you are interested in financing your new home purchase. You have your choice of a myriad financing options. You could enter into any one of the following agreements: 8% fixed rate for 7 years, 8.5% fixed rate for 15 years, 9% fixed for 30 years. In addition, you could finance with a 30-year variable rate that begins at 5% and increases and decreases with the prime rate, or you could finance with a 30-year variable rate that begins at 6% with ceilings of 2% per year to a maximum of 12% and no minimum.
a. Suppose you believe that interest rates are on the rise. If you want to completely eliminate your risk of rising interest rates for the longest period of time, which option should you choose?
b. Would you consider that hedging or insuring? Why
c. What does your risk-management decision “cost” you in terms of quoted interest rates during the first year?
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