Test Bank for Real Estate Finance & Investments 17th Edition by Ace Test Banks

Test Bank for Real Estate Finance & Investments 17th Edition

richard@qwconsultancy.com

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Real estate refers to the physical land and improvements constructed on the land. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

Real property refers to the ownership rights associated with real estate. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

3) A quitclaim deed says that the grantor "quits" whatever claim he has in the property in favor of the grantee. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

It is illegal to give a quitclaim deed if the grantor has no claim in the property. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

5) The term real estate refers to the ownership rights associated with the physical land and improvements. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

A fee simple estate is a type of freehold estate. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

7) As compared to other types of deeds, a general warranty deed provides the most comprehensive warranties about the quality of the title to the property. ⊚ true ⊚ false

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Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Topic : Assurance of Title Gradable : automatic

8) After a house is purchased, contractors cannot ask the new owner of the house to pay any bills that were outstanding before the house was sold. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Topic : Assurance of Title Gradable : automatic

9) A reciprocal easement agreement allows two or more parties to access each other's property. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

10) A lien waiver provides certification that contractor's on newly constructed properties have been compensated. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Topic : Assurance of Title Gradable : automatic

11)

A lessee is a person who holds the title to a piece of property. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

12)

The grantee typically conveys title to the grantor by means of a deed. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 13) If a lender is to repossess or bring about the sale of a property if the borrower defaults on the mortgage loan, the lender is said to have a __________ in the real estate.

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A) freehold interest B) lease interest C) secured interest D) quitclaim

Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 2 Understand Gradable : automatic

14) A(n) __________ estate represents the most complete form of ownership of real estate; the owner is free to divide it up into lesser estates and sell, lease, or borrow against them as he or she wishes. A) fee simple B) freehold C) leasehold D) life

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

15) Mr. Smith has allowed Mrs. Jones to run a sewer line through Mr. Smith's backyard so that Mrs. Jones has access to the city sewer system. This is an example of a(n):

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A) easement. B) encumbrance. C) estate for years. D) title assurance.

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

16)

Which type of deed offers the grantee the MOST protection? A) Quitclaim deed B) Special warranty deed C) General warranty deed D) Officer's deed

Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Topic : Assurance of Title Gradable : automatic

17) What term BEST describes a person that owns a property and is conveying title to the property to another person? A) Mortgagor B) Grantor C) Mortgagee D) Grantee

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Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

18)

What type of estate lasts for an indefinite period of time? A) Freehold estate B) Estate from year-to-year C) Leasehold estate D) Estate for years

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

19)

Which of the following is NOT a good method of title assurance? A) Seller provides a warranty in the deed B) An attorney searches recorded documents C) Title insurance is purchased D) Seller provides a quitclaim deed

Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Topic : Assurance of Title Gradable : automatic

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20)

What legal document conveys title from one person to another?

A) Mortgage B) Note C) Deed D) Debenture

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Topic : Assurance of Title Gradable : automatic

21) A historical summary of the publicly-recorded documents that affect the ownership of a property is known as a(n): A) estate. B) deed. C) abstract of title. D) lien.

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Topic : Assurance of Title Gradable : automatic

22)

Which of the following is FALSE regarding a tax sale?

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A) An accurate and complete description of the property is required to be posted for possible purchasers before the sale. B) The property owner may not have had a court appearance through due process, thus creating a cloud on the title. C) The line of authority for the sale may not be clear. D) The purchaser is usually expected to pay all delinquent taxes at the time of sale.

Question Details Difficulty : 3 Hard Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Topic : Assurance of Title Gradable : automatic

23)

A reversion and a remainder are similar in that: A) both can be sold or mortgaged. B) both cause the property to go back to the grantor after the sale. C) neither is an actual interest in the property. D) neither is considered a future estate.

24)

Which of the following is FALSE concerning mechanic's Liens? A) Gives the right to attach a lien on real estate B) Can get money through forcing judicial sale C) Lasts even after the bill for labor and materials has been paid D) Might not be disclosed by the public records

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Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Topic : Assurance of Title Gradable : automatic

25) All other items not considered realty, including intangibles and movable things, are considered as: A) realty. B) contractual. C) personality. D) an estate.

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

26)

A term used to link an individual or entity who owns property to the property itself is: A) easement. B) title. C) deed. D) lease.

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Property Rights and Estates Bloom's : Level 1 Remember Gradable : automatic

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Answer Key Test name: Ch01 1) TRUE We generally use the termreal estate to mean land and all things permanently attached. 2) TRUE Ownership rights associated with real estate are referred to as real property. 3) TRUE The quitclaim deed simply says that the grantor “quits” whatever “claim” he or she has in the property (which may well be none) in favor of the grantee. 4) FALSE A quitclaim deed offers the grantee the least protection. Such a deed simply conveys to the grantee whatever rights, interests, and title that the grantor may have in the property. No warranties are made about the nature of these rights and interests or of the quality of the grantor’s title to the property. 5) FALSE The term real estate is used to refer to things that are not movable such as land and improvements permanently attached to the land, and ownership rights associated with the real estate are referred to as real property. 6) TRUE

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A fee simple estate, also known as a fee simple absolute estate, is the freehold estate that represents the most complete form of ownership of real estate. 7) TRUE A general warranty deed is the most commonly used deed in real estate transactions and the most desirable type of deed from the buyer’s perspective. It offers the most comprehensive warranties about the quality of the title. 8) FALSE State laws generally give contractors, laborers, or suppliers of materials a certain period of time following the completion of work or delivery of materials during which to file their lien. When the lien is filed, it “relates back” and takes priority over all liens filed after the time when materials were first delivered or work was first performed on the real estate. As a result, until the end of the time allowed for filing (generally 60 days), a purchaser of an interest in newly constructed or improved real estate cannot be sure that the interest will be unencum¬bered or that the interest will have the priority bargained for. 9) TRUE An easement is a nonpossessory interest in land. It is the right to use land that is owned or leased by someone else for some special purpose. Reciprocal easements allow access across both properties, thereby enhancing customer traffic flow and shopping opportunities. 10) TRUE In practice, owners of properties that are newly constructed or renovated should require contractors, workers, and material suppliers to sign a lien waiver. This is an acknowledgment that they have been compensated and that they agree to waive all lien rights. Version 1

11) FALSE A lessee is a person who leases land or property. 12) FALSE Usually title is conveyed from one person (the grantor) to another (the grantee) by means of a written instrument called a deed. 13) C The mortgage document provides the lender with evidence of a secured interest. This right has value to the lender and reduces the quantity of rights possessed by the owner. 14) A A fee simple estate represents the most complete form of ownership of real estate, whereas a leasehold estate usually describes rights and interests obtained by tenants when leasing or renting a property. The latter is also a possessory interest and involves the general right to occupy and use the property during the period of possession. 15) A An easement is a nonpossessory interest in land. It is the right to use land that is owned or leased by someone else for some special purpose. 16) C A general warranty deed is the most commonly used deed in real estate transactions and the most desirable type of deed from the buyer’s perspective. It offers the most comprehensive warranties about the quality of the title. 17) B Usually title is conveyed from one person (the grantor) to another (the grantee) by means of a written instrument called a deed. 18) A Version 1

A freehold estate lasts for an indefinite period of time; that is, there is no definitely ascertainable date on which the estate ends. A leasehold estate, on the other hand, expires on a definite date. 19) D A quitclaim deed offers the grantee the least protection. Such a deed simply conveys to the grantee whatever rights, interests, and title that the grantor may have in the property. No warranties are made about the nature of these rights and interests or of the quality of the grantor’s title to the property. 20) C Usually title is conveyed from one person (the grantor) to another (the grantee) by means of a written instrument called a deed. 21) C An abstract of title is a historical summary of the publicly recorded documents that affect a title. 22) A In a tax sale, an accurate and complete description of the property is not required to be posted prior to the sale. 23) A A reversionary interest can be sold or mortgaged because it is an actual interest in the property. A remainder exists when an owner wishes for another party to occupy and use a property for a specified number of years or for his life, then upon expiration of that time or upon his death, the estate is conveyed to a third party. Both types may be mortgaged or sold. 24) C

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In general, mechanics’ liens give unpaid contractors, workers, and material suppliers the right to attach a lien on the real estate to which they added their labor or materials. These liens may not be disclosed in public records. To obtain the payment owed them, they may foreclose such liens by forcing a judicial sale of the encumbered property. They are then paid from the proceeds of the sale. The lien ends when the bills for the labor and/or materials have been paid. 25) C All other items not considered realty have been designated as personalty, which includes all intangibles and movable things (e.g., automobiles, shares of stock, bank accounts, and patents). 26) B Title is an abstract term frequently used to link an individual or entity who owns property to the property itself. When a person has “title,” he is said to have all of the elements, including the documents, records, and acts that prove ownership.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) A mortgage is the same thing as a note. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

2) A nonrecourse loan is one in which the borrower is personally liable for payment of all amounts due under the terms of the note. ⊚ true ⊚ false Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

Prepayment of a loan without penalty is a right of all borrowers. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

4) A second mortgage is a junior lien mortgage that is sometimes used to bridge the gap between the price of a property and the sum of the first mortgage and down payment.

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⊚ ⊚

true false

Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

A remainder cannot be mortgaged. ⊚ true ⊚ false

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

6) A clause which specifies that the mortgagor will pay all property taxes and other charges assessed against the property, even if these charges have priority over the mortgage, is typically included in a mortgage. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

7) A clause which specifies that the mortgagee will obtain and maintain personal property insurance is typically included in a mortgage. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

8) Under lien theory, title and the right to possession pass from the mortgagor to the mortgagee when the mortgage is executed. ⊚ true ⊚ false Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

9) A due on sale clause which specifies that the mortgage can accelerate the debt if the property is sold without the mortgagee’s permission is a typical clause in a mortgage document. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

10)

It is a federal law that a mortgage must be recorded to be valid. ⊚ true ⊚ false

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Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

11)

A mortgage default can result from failure to pay property taxes. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Default Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

12)

A technical default can result from failure to keep the property in repair. ⊚ true ⊚ false

Question Details Topic : Default Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

13) When a purchaser takes a property "subject to" an existing mortgage, the purchaser becomes personally liable for repaying the debt. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

14) When a deed is given in lieu of foreclosure of the mortgage, the mortgagor no longer has an obligation to pay the mortgage note. ⊚ true ⊚ false Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

15)

Junior liens are eliminated by a voluntary conveyance of a property to the mortgagee. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Foreclosure Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

16) If a property encumbered by a mortgage is sold at a foreclosure sale for an amount more than the value of the mortgage, the mortgagor is not obligated to pay the mortgagee the remaining balance. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : Foreclosure Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

17) A purchaser at a tax sale receives a deed to the property at the time of the sale in nearly all states. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Foreclosure Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

18) The process of confirming a plan of reorganization under Chapter 11 bankruptcy, even if one or more creditor classes dissent, is known as a "cramdown." ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Bankruptcy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

19) If a debtor, under Chapter 7 bankruptcy, is not behind on his mortgage payments, he does not have to give up the property. ⊚ true ⊚ false

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Question Details Topic : Bankruptcy Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

20) Unless stated otherwise, the borrower is personally liable for payment of all amounts due under the terms of the note. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Foreclosure Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

21)

A short sale occurs when a buyer does not bring adequate funds to a mortgage closing. ⊚ true ⊚ false

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 22) A loan in which the borrower arranges in advance with a mortgagee for a total amount that will be advanced, in stages, under the mortgage to meet the part of the costs of construction as it progresses is a(n):

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A) assumption of the mortgage. B) nonrecourse mortgage. C) open-end mortgage. D) subordination of the mortgage.

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

23)

A "short sale" of real estate is:

A) a sale that closes in less than 30 days. B) the sale of a house by someone who is not the owner; it is a way to profit from an anticipated decline in real estate prices. C) a sale in which the proceeds from the sale are less than the balance owed on the loan secured by the property sold. D) a sale in which the balance owed on the loan secured by the property sold is less than the proceeds from the sale.

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

24) Which of the following situations is NOT a common cause for the use of a purchasemoney mortgage?

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A) The buyer cannot come up with the down payment needed to qualify for a mortgage. B) The seller wants to receive the gain from the sale in installments. C) Third-party mortgage financing is too expensive or unavailable. D) The seller desires to artificially raise the price of the property by receiving a higherthan-market interest rate.

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

25)

Which of the following is NOT a minimum mortgage requirement? A) Description of the property B) Covenant of warranty C) Prepayment clause D) Covenant of seizin

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

26)

A mortgage is BEST defined as a legal document that: A) creates an obligation to repay a loan under specific terms. B) names real estate as the security or collateral for the repayment of a loan. C) defines a possessory interest in real estate. D) conveys ownership of a property to its purchaser.

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Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

27) Which of the following solutions is LEAST likely to be acceptable to a mortgagee when discussing alternatives to foreclosing a property? A) Permanently extending the amortization period B) Finding someone else to assume the mortgage C) Providing a temporary grace period during which principal and interest are not paid D) Permanently reducing the interest rate

Question Details Difficulty : 1 Easy Topic : Foreclosure Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

28) Which of the following terms refers to an owner’s right to redeem a property after foreclosure? A) Equity of redemption B) Statutory redemption C) Attachment D) Execution

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Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

29) In jurisdictions where a deed of trust is used to finance real estate, there are three parties to the loan secured by the deed of trust. Which of the following is NOT one of those three parties? A) Borrower B) Trustee C) Holder of the note D) Grantor

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

30) A senior mortgage holder is owed a mortgage balance of $140,000 and brings a foreclosure suit which includes all junior claimants in the suit. If the senior mortgage holder purchases the property for $140,000 at the foreclosure sale, what happens to the claim of the junior claimants? A) The liens of the junior claimants are unaffected and the debt is due upon sale. B) The liens of the junior claimants are extinguished, but the debt owed to the junior claimants is unaffected. C) The liens of the junior claimants and the debt owed to them are extinguished. D) The liens of the junior claimants are unaffected, but the debt owed to them is extinguished.

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Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

31)

A property is encumbered as follows:

First mortgage, A: $250,000 Second mortgage, B: $40,000 Third mortgage, C: $10,000 How much can mortgagee B pay for the property at a foreclosure sale without having to raise additional funds? A) $290,000 B) $40,000 C) $300,000 D) $50,000

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

32) Which of the following types of bankruptcy is filed with the end result of liquidating the debtor’s assets? A) Chapter 7 B) Chapter 11 C) Chapter 13 D) Chapter 17

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Question Details Difficulty : 1 Easy Topic : Bankruptcy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

33) Which of the following types of bankruptcy is available to a business to reorganize and rehabilitate the debtor? A) Chapter 7 B) Chapter 11 C) Chapter 13 D) Chapter 17

Question Details Difficulty : 1 Easy Topic : Bankruptcy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

34)

A mortgage agreement provides the lender with __________ interests. A) unsecured B) secured C) nonpossessory D) possessory

Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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35) What is usually executed at the same time as a mortgage and creates the obligation to repay the loan in accordance with its terms? A) Recording acts B) Ownership interests C) Method of payment D) Promissory note

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

36) Which of the following gives the lender the right or option to demand the loan balance owed if a default occurs? A) Nonrecourse clause B) Assignment clause C) Acceleration clause D) Default clause

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

37)

Which of the following is NOT an alternative to foreclosure?

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A) Restructuring the mortgage loan B) Transfer of the mortgage to a new owner C) Redemption D) Prepackaged bankruptcy

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

38)

Which of the following types of default LEAST often results in foreclosure? A) Failure to fulfill financial obligation B) Failure to pay taxes C) Failure to pay insurance premiums when due D) Failure to keep the security in repair

Question Details Topic : Default Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

39)

Which of the following statements is FALSE regarding foreclosure?

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A) In judicial foreclosure, property subject to attachment and execution is limited to the mortgaged property. B) If the sale of the mortgaged property realizes a price above the claims of the mortgage and expense of the sale, the balance goes to the mortgagor. C) Redemption can be accomplished by paying the full amount of the debt, interest, and costs due to mortgage. D) The purchaser of property at a foreclosure sale is, in effect, the purchaser of the rights of the mortgagor whose interests are cut off by the sale.

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

40)

When would seller financing NOT be used?

A) The seller desires to take advantage of the installment method of reporting the gain from sale. B) The buyer does not qualify for long-term mortgage credit because of low down payment or difficulty meeting monthly payments. C) Third-party mortgage financing is less expensive or easily available. D) The seller desires to artificially raise the price of the property by offering a lowerthan-market interest rate on the mortgage.

Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

41) A situation in which a borrower agrees to a court's jurisdiction and cooperates with the lender during litigation to resolve the situation is: Version 1

A) prepackaged bankruptcy. B) judicial foreclosure. C) friendly foreclosure. D) voluntary conveyance.

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

42) A transaction in which a borrower sells a property for less than the current balance of the loan and then provides all of the proceeds to the sale to the lender, typically in full satisfaction of the loan is: A) prepackaged bankruptcy. B) short sale. C) judicial foreclosure. D) friendly foreclosure.

Question Details Topic : Foreclosure Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

43) What term BEST describes the borrower who is personally liable for a debt obligation related to the purchase of a home?

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A) Mortgagor B) Grantor C) Mortgagee D) Grantee

Question Details Difficulty : 1 Easy Topic : The Mortgage Instrument Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

44) The term to describe a piece of tangible personal property that is affixed to a property, such that it may be considered part of the property? A) Cramdown B) Workout C) Redemption D) Chattel

Question Details Topic : The Mortgage Instrument Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

45) Which of the following documents conveys title to a property at the time the purchaser completes the performance of the obligation called for in the document? A) Junior mortgage B) Package mortgage C) Purchase-money mortgage D) Land contract

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Question Details Difficulty : 1 Easy Topic : Land contracts Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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Answer Key Test name: Ch02 1) FALSE A note is a document that serves as evidence that debt exists between a borrower and a lender, whereas a mortgage conveys title. 2) FALSE A nonrecourse loan is one in which the lender agrees not to, or specifies conditions under which it will not, hold the borrower personally liable in the event of a default. 3) FALSE Prepayment is a privilege but not a right. 4) TRUE One junior lien, usually called a second mortgage, is sometimes used to bridge the gap between the price of the property and the sum of the first mortgage and the amount of money available to the purchaser to use as a down payment. 5) FALSE A remainder is considered a diverse, mortgageable interest. 6) TRUE Because loans are secured by properties and are made for very long periods of time, lenders want assurance that borrowers will pay property taxes, so a clause of this nature is often included in the mortgage. 7) FALSE

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A clause regarding hazard insurance is often included in the mortgage but the lender is not concerned with whether personal goods inside the home are insured. 8) FALSE Title and the right to possession fully pass to the mortgagee once the loan is fully paid, not when it is executed. 9) TRUE The due-on-sale clause, allows the mortgagee to accelerate the debt (i.e., to take action to make the outstanding loan balance plus accrued interest immediately due and payable) when the property, or some interest in the property, is transferred without the written consent of the mortgagee. 10) FALSE Unless the statutes of the state require it, recording is not essential to the validity of a mortgage because it is an agreement between the mortgagor and the mortgagee. 11) TRUE Failure to pay property taxes is a valid reason for a loan default. 12) TRUE A failure to keep the security in repair may constitute what is commonly referred to as a technical default. However, because a breach of contract resulting in a technical default can usually be cured by a borrower. 13) FALSE The seller retains personal liability for the debt when the property is sold “subject to” an existing mortgage. 14) TRUE The deed replaces the requirement to pay the mortgage note when given in lieu of foreclosure. Version 1

15) FALSE If there are junior liens outstanding, they are not eliminated by a voluntary conveyance. 16) FALSE When a property encumbered by a mortgage is sold at foreclosure and the property value exceeds the mortgage balance, a sum may be paid to the mortgagors for their equity. 17) FALSE At the time of the tax sale, the purchaser receives a tax certificate, which is then subject to redemption in nearly all states. 18) TRUE Even if one or more creditor classes dissent, the court can still confirm the plan if it meets certain statutory requirements. When the court decides that the bankruptcy plan is satisfactory in spite of the objections of creditors, the confirmation of the plan is known as cramdown. 19) TRUE To foreclose on the mortgage and sell the debtor’s property, the lender must first petition the bankruptcy court. If the debtor is not behind in the mortgage payments and desires to retain the property, he or she may do so by reaffirming the mortgage debt. 20) TRUE The terms of the note outline the amounts due and obligate the borrower to pay those amounts. 21) FALSE A short sale occurs when the lender agrees to a sale price that is less than the loan balance. 22) C Version 1

In an open-end mortgage, the borrower arranges in advance with a mortgagee for a total amount, usually definitely stated in the mortgage, that will be advanced, in stages, under the mortgage to meet the part of the costs of construction as it progresses. 23) C A short sale is a sale of real estate in which the proceeds from the sale fall short of the balance owed on a loan secured by the property sold. 24) D A higher-than-market interest rate will not artificially raise the price of the property and this is not a reason for using a purchase-money mortgage. 25) C Prepayment clauses are privileges but not rights. 26) B Mortgages are legal documents that list the underlying real estate as the collateral for the loan. 27) D The lender seeks to be compensated in full based on the original loan terms, so it is not in the lender’s interest to reduce the interest rate. 28) B Once the foreclosure sale has been confirmed, the mortgagor can no longer redeem the property, except in states that provide for a statutory period for redemption after foreclosure. The right to redeem after foreclosure is called the right of statutory redemption, which exists in about half of the states. 29) D

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There are three parties to a loan secured by a deed of trust. The borrower (creator of the trust) conveys the title to the property to be used as security to a trustee, who holds it as security for the benefit of the holder of the note executed by the borrower when the loan was made. 30) B When a senior mortgage holder purchases property at foreclosure, while the liens to junior claimants are eliminated, the debts owed to these claimants remain. 31) A Mortgagee B will pay the sum of the first mortgage and the second mortgage, so $250,000 + $40,000 = $290,000. 32) A The purpose of Chapter 7, or “straight bankruptcy,” is to give debtors a fresh start by discharging all of their debts and liquidating their nonexempt assets. 33) B A Chapter 11 proceeding looks to the preservation of the debtor’s assets while a plan of reorganization to rehabilitate the debtor is formulated. 34) B Real estate is generally regarded by lenders as excellent security for a loan, and lenders acquire a secured interest in the real estate with a mortgage. 35) D A promissory note is a document that serves as evidence that debt exists between a borrower and a lender. It usually contains the terms under which the loan must be repaid and the rights and responsibilities of both parties.

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36) C The acceleration clause allows the lender toaccelerate on the note by demanding that all remaining amounts owed under the loan agreement be paid immediately by the borrower. 37) C Redemption is the process of canceling or annulling a title conveyed by a foreclosure sale by paying the debt or fulfilling the other conditions in the mortgage. It is not an alternative to foreclosure. 38) C Failure to pay insurance premiums may result in loss of insurance but this does not necessarily lead to foreclosure. 39) B When the property value exceeds the mortgage balance, a sum may be paid to the mortgagors for their equity. 40) C When third-party financing is easily available and provides good terms, then it would be used versus seller financing. 41) C A friendly foreclosure is a foreclosure action in which the borrower submits to the jurisdiction of the court, waives any right to assert defenses and claims and to appeal or collaterally attack any judgment, and otherwise agrees to cooperate with the lender in the litigation. 42) B A short sale is a sale of real estate in which the proceeds from the sale fall short of the balance owed on a loan secured by the property sold. 43) A

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The mortgagor is the borrower who is personally liable for the obligation. 44) D In general, a fixture is an item of tangible personal property also referred to as chattel that has become affixed to or is intended to be used with the real estate, so as to be considered part of the property. 45) D A land contract conveys title at such time as the purchaser completes the performance of the obligation called for in the contract.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) In a compounding problem, you must know all four of the variables to solve for the fifth variable. ⊚ true ⊚ false Question Details Topic : General TVM Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember Gradable : automatic

2) One way to calculate the present value of a single payment is with the following formula: PV = FV * (1 + i)n. ⊚ true ⊚ false Question Details Topic : General TVM Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember Gradable : automatic

3) Assuming an interest rate of 6 percent, the present value of $1 that will be received a year from now is $.75. ⊚ true ⊚ false Question Details Topic : General TVM Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember Gradable : automatic

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4) The future value of $800 deposited today would be greater if that deposit earned 8 percent rather than 7.75 percent. ⊚ true ⊚ false Question Details Topic : General TVM Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember Gradable : automatic

5) due.

In business, you see the use of an ordinary annuity and never see the use of an annuity ⊚ ⊚

true false

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6) The internal rate of return is the good feeling you get inside when you earn a return on your investment. ⊚ true ⊚ false Question Details Topic : IRR Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember Gradable : automatic

An investment may have more than one internal rate of return.

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⊚ ⊚

true false

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8) Assume that an investment, with a single initial cost of $1,000 and a yield of $50 monthly for 10 years, had a 7 percent IRR in the 60th month and a 7.2 percent IRR five months later. The IRR can be 6.8 percent in the 62nd month. ⊚ true ⊚ false Question Details Topic : IRR Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 3 Hard Bloom's : Level 3 Apply Gradable : automatic

9) The future value of a $1 annuity compounded at 5 percent annually is greater than the future value of a $1 annuity compounded at 5 percent semiannually. ⊚ true ⊚ false Question Details Topic : General TVM Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember Gradable : automatic

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 10) If you deposit $1,000 in an account that earns 5 percent per year (compounded monthly), what will the balance in the account be at the end of 5 years? A) $1,272 B) $1,276 C) $1,280 D) $1,283

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11) Ten years ago, you put $150,000 into an interest-earning account. Today it is worth $275,000. What is the effective annual interest earned on the account? A) 47.99% B) 6.00% C) 6.25% D) 8.33%

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12) Your friend has a trust fund that will pay him $100,000 at the end of 10 years. Your friend, however, wants his money today. He promises to sign his trust fund over to you if you give him some money today. You require a 20 percent interest rate on money you lend to friends. How much would you be willing to lend under these terms? Version 1

A) $16,151. B) $50,000 C) $80,000 D) $0—it would be impossible to earn 20 percent interest on the loan.

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13) A deposit placed in an interest-earning account earning 8 percent a year will double in value in __________ years. A) 6 B) 8 C) 9 D) 72

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14) At the end of 8 years, your friend wants to have $50,000 saved for a down payment on a house. He expects to earn 8 percent (compounded monthly) on his investments over the next 8 years. How much would your friend have to put in his investment account each month to reach his goal?

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A) $188 B) $374 C) $392 D) $521

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15) Your friend just won the lottery. He has a choice of receiving $50,000 a year for the next 20 years or a lump sum today. The lottery uses a 15 percent discount rate. What would be the lump sum amount your friend would receive? A) $312,967 B) $316,426 C) $500,000 D) $1,000,000

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16) The future value of a single deposit of $1,000 will be greatest when this amount is compounded:

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A) annually B) semi-annually C) quarterly D) monthly

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17) The future value of $1,000 compounded annually for 8 years at 12 percent may be calculated with the following formula: FV = $1,000 * (1 + 12%)8 If the same $1,000 was compounded quarterly, what formula would you use to calculate the FV? A) FV = $1,000 * (1 + 3%)8 B) FV = $1,000 * (1 + 12%)32 C) FV = $1,000 * (1 + 3%)32 D) FV = $1,000 * (1 + 12%)2

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18) If you saw a table containing the following factors, what kind of interest factor would you be looking at? End of Year

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1 2 3 4 5

1.06000 1.12360 1.19102 1.26248 1.33823

A) Present value of a single amount B) Future value of a single amount C) Present value of an annuity D) Future value of an annuity

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19) Begin with a single sum of money at Period 0. First, calculate a future value of that sum at 12.01 percent. Then discount that future value back to Period 0 at 11.99 percent. In relation to the initial single sum, the discounted future value: A) is greater than the original amount. B) is less than the original amount. C) is the same as the original amount. D) cannot be determined with the information given.

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20)

The future value compound factor given for period (n) at 15 percent:

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A) would be less than the factor for period (n + 1) at 15 percent. B) would be greater than the factor given for period (n + 1) at 15 percent. C) would be the same as the factor given for period (n + 1) at 15 percent. D) bears no relationship to the factor for period (n + 1) at 15percent.

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21)

Which of the following is not a basic component of any compounding problem? A) An initial deposit B) An interest rate C) A period of time D) A net present value

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22)

If an investment earns 12 percent annually:

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A) an equivalent monthly investment would have to earn a higher equivalent nominal rate to yield the same return. B) an equivalent monthly investment would have to earn a lower equivalent nominal rate to yield the same return. C) an equivalent monthly investment would have to earn the same equivalent nominal rate to yield the same return. D) a relationship cannot be determined between a monthly and annual investment.

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23)

The internal rate of return:

A) is also known as the investment of investor's yield. B) represents a return on investment expressed as a compound rate of interest. C) is calculated by setting the price of an investment equal to the stream of cash flows it generates and solving for the interest rate. D) can be defined by all of the choices.

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24) Using only the information in the table below, what would the IRR be for an investment that cost $500 in period 0 and was sold for $750 in period 5? Present Value Factor for Reversion of $1

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Period 1 2 3 4 5 6

6% 0.943396 0.889996 0.839619 0.792094 0.747258 0.704961

7% 0.934579 0.873439 0.816298 0.762895 0.712986 0.666342

8% 0.925926 0.857339 0.793832 0.735030 0.680583 0.630170

9% 0.917431 0.841680 0.772183 0.708425 0.649931 0.596267

10% 0.909091 0.826446 0.751315 0.683013 0.620921 0.564474

A) Between 6% and 7% B) Between 7% and 8% C) Between 8% and 9% D) Between 9% and 10%

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25) Using only the information in the table below, approximately how much would you pay today for an investment that pays $0 annual interest, but earns 8 percent interest over the next four years and has a face value at maturity of $13,500? Present Value Factor for Reversion of $1 Period 1 2 3 4 5 6

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6% 0.943396 0.889996 0.839619 0.792094 0.747258 0.704961

7% 0.934579 0.873439 0.816298 0.762895 0.712986 0.666342

8% 0.925926 0.857339 0.793832 0.735030 0.680583 0.630170

9% 0.917431 0.841680 0.772183 0.708425 0.644931 0.596267

10% 0.909091 0.826446 0.751315 0.683013 0.620921 0.564474

A) $8,000 B) $9,000 C) $10,000 D) $11,000

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26)

A series of equal, annual cash flows that are received at the end of each period is a(n): A) ordinary annuity. B) annuity due. C) regular annuity. D) ordinary annuity due.

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27) An investment that costs $105,000 today is expected to produce the following cash inflows over each of the next five years: $20,000; $25,000; $23,000; $22,000; $21,000. What is the IRR (compounded annually) for this investment? A) 188.6% B) 18.9% C) 1.89% D) −18.9%

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28) If Beth makes an initial investment of $1,000, how much will it be worth after three years if her average return is 8.25 percent (compounded monthly)? A) $1,268.48 B) $17,354.20 C) $1,279.74 D) $1,020.77

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29) For situations calling for other than annual compounding, each of these factors (when present) must be adjusted for the number of compounding periods in a year: A) PV and FV. B) N and i. C) N, i, and PMT. D) N, i, PV, and PMT.

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30) How much money does Ted need to invest each month in order to accumulate $10,000 over a five-year period, if he expects to get a return of 5.625 percent per year? A) $144.71 B) $1,787.30 C) $148.94 D) $146.36

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Answer Key Test name: Ch03 1) TRUE In solving a compounding problem, there should only be one unknown variable. 2) FALSE PV =FV/(1 +i)n. 3) FALSE PV(0.06, 1, 0, -1) 4) TRUE Higher interest rates result in higher future values of given amounts, all else held equal. 5) FALSE Both ordinary annuities and annuities due are used in business settings. 6) FALSE The internal rate of return is the amount of money that will be earned or lost on the investment if it is undertaken. 7) TRUE One could sell the investment at different times. Hence, the IRR could vary. 8) FALSE 6.8 percent is lower than both presented IRRs. It could only be lower if there was a substantial negative cash flow in month 62. 9) FALSE

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The more frequent the compounding, the higher the future value, all else held equal. 10) D = FV(0.05/12,5 × 12,,−1000) 11) C RATE(10, 0, −150,000, 275,000) 12) A PV(0.2, 10, 0, −100,000) 13) C NPER(0.08, 0, −1, 2) 14) B = PMT(0.08/12,8 × 12,,−50000) 15) A = PV(0.15,20,−50000) 16) D More frequent compounding results in higher future values, all else held equal. 17) C The rate is divided by 4 as there are 4 quarters per year. The number of periods is multiplied by the same value, which is 4. 18) B The figures represent the “6% interest rate” column of the future value of a single amount factor table. For example, = FV(0.06,1,,−1) = 1.06000. 19) A

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Because the net interest rate is positive (12.01 − 11.99 = 0.02), then the discounted amount will be higher than the original amount. 20) A The higher the number of time periods for compounding, the higher the future value factor, all else held equal. 21) D Net present value is not a required variable in all compounding problems. 22) B The more frequent the compounding periods, the lower rate is required to yield the same return as that of an investment with fewer compounding periods, all else held constant. 23) D The internal rate of return is also called the yield and represents a return on the investment. It is calculated by setting the price of an investment equal to the stream of cash flows it generates and solving for the rate. 24) C $500/$750 = 0.666667. For the Period = 5 row, this value falls between 8 and 9 percent. 25) C In the table, find the value in the 8% column and 4 row, which is 0.735030. Then, multiply by the face value at maturity, so $13,500 × 0.73503 = $9,923, which is closest to $10,000. 26) A Ordinary annuity payments are received at the end of the period. 27) C

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Enter CF CFj = −$105,000 CFj = $20,000 CFj = $25,000 CFj = $23,000 CFj = $22,000 CFj = $21,000

Enter nj nj = 1 nj = 1 nj = 1 nj = 1 nj = 1 nj = 1

Solve for (i) = 1.89% 28) C N = 36; i = 8.25%/12; PV = $1,000; PMT = $0; CPT FV = $1,279.74. 29) C The periods, interest rate, and payments must be adjusted when compounding occurs in any other frequency than annually. 30) A N = 60; i = 5.625%/12; PV = $0; FV = $10,000; CPT PMT = $144.71/month.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Inflation makes very little difference to lenders of and investors needing money. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Mortgage Characteristics Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

Lenders and investors worry about default, interest rate, marketability, and liquidity risks. ⊚ true ⊚ false

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3) One difference between the constant amortizing mortgage (CAM) and the constant payment mortgage (CPM) is the interest paid and loan amortization relationship. With a CAM, the loan amortization and interest paid are directly related and with the CPM the loan amortization and the interest paid are inversely related. ⊚ true ⊚ false Question Details Topic : Mortgage Characteristics Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand Gradable : automatic

Determining a loan balance on a CPM is a simple present value of an annuity problem.

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⊚ ⊚

true false

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5) loan.

The effective interest rate on a mortgage will always be higher than the stated rate of the ⊚ ⊚

true false

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Truth-in-lending requires the borrower to tell the truth on the loan application. ⊚ true ⊚ false

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The annual percentage rate closely approximates the borrower's true cost of funds. ⊚ true ⊚ false

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8) it.

Prepayment penalties increase the lender’s mortgage yield and discount points decrease ⊚ ⊚

true false

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Origination fees are tax deductible as an interest expense. ⊚ true ⊚ false

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10) Graduated payment mortgages (GPMs) are loans available to people who have graduated from college. ⊚ true ⊚ false

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11) Borrowers with fixed rate mortgages generally benefit if actual inflation is higher than expected inflation. ⊚ true ⊚ false Question Details Topic : Mortgage Characteristics Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand Gradable : automatic

12)

The APR for a loan assumes it is prepaid after ten years. ⊚ true ⊚ false

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13)

With a reverse mortgage the borrower receives payments from the bank. ⊚ true ⊚ false

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14) A reverse mortgage can be a good option for first-time homebuyers who cannot make a substantial down payment. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Reverse Mortgages Bloom's : Level 1 Remember Gradable : automatic

15) With a negative amortizing loan, the borrower will end up with a loan balance at the end of the loan that is greater than the original loan balance. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Topic : Negative Amortization Bloom's : Level 1 Remember Gradable : automatic

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) A borrower takes out a 30-year mortgage loan for $250,000 with an interest rate of 5 percent. What would the monthly payment be?

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A) $694 B) $1,042 C) $1,342 D) $1,355

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17) A borrower takes out a 30-year mortgage loan for $250,000 with an interest rate of 5 percent and monthly payments. What portion of the first month's payment would be applied to interest? A) $694 B) $1,042 C) $1,342 D) $1,355

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18) A borrower has a 30-year mortgage loan for $200,000 with an interest rate of 6 percent and monthly payments. If she wants to pay off the loan after 8 years, what would be the outstanding balance on the loan?

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A) $84,886 B) $91,246 C) $146,667 D) $175,545

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19) A borrower takes out a 30-year mortgage loan for $100,000 with an interest rate of 6 percent plus 4 points. What is the effective annual interest rate on the loan if the loan is carried for all 30 years? A) 5.6% B) 6.0% C) 6.4% D) 6.6%

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20) A borrower obtains a $150,000 reverse mortgage with monthly payments over 10 years. If the interest rate of the mortgage loan is 8% percent what is the monthly payment received by the borrower?

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A) $820 B) $863 C) $1,250 D) $1,820

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21) Which of the following is NOT a determinant of interest rates for single family residential mortgages? A) The demand and supply of mortgage funds B) Inflation expectations C) Liquidity D) The demand and supply of apartments

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22) Risk is an important component of interest rates. Which of the following risks is NOT a determinant of interest rates?

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A) Default risks B) Interest rate risks C) Institutional risks D) Marketability risks

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23) One of the first amortizing mortgages was the constant amortization mortgage (CAM). Which of the following characterized the components of the CAM payment over the life of the loan? Interest (A) (B) (C) (D)

Amortization

Decreasing Constant Decreasing Constant

Decreasing Decreasing Constant Constant

Payment Decreasing Decreasing Decreasing Constant

A) Option A B) Option B C) Option C D) Option D

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24) One of the most popular amortizing mortgages today is the constant payment mortgage (CPM). Which of the following characterizes the components of the CPM payment over the life of the loan? Interest (A) (B) (C) (D)

Amortization

Decreasing Increasing Decreasing Constant

Decreasing Decreasing Increasing Constant

Payment Decreasing Constant Constant Constant

A) Option A B) Option B C) Option C D) Option D

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25) In comparison to the first month’s payment of a CAM, the first month’s payment of a CPM: A) is higher. B) is lower. C) is the same. D) cannot be determined with this information.

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26) the:

At the end of five years, calculating the loan balance of a constant payment mortgage is

A) present value of a single amount. B) future value of a single amount. C) present value of an ordinary annuity. D) future value of an annuity due.

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27)

Which of the following closing costs DO NOT increase the lender’s effective loan yield? A) Discount points B) Prepayment penalties C) Title insurance charges D) Origination fees

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28) Which mortgage would a borrower prefer to have during inflationary and recessionary periods? Inflationary

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Inflationary

(A) (B) (C) (D)

CPM GPM CPM CPM

GPM CAM CAM GPM

A) A B) B C) C D) D

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29) Over the life of the loan, which of the following loans would continually have a lower principal balance given each loan had the same term, principal amount, and average interest rate? A) CAM B) CPM C) GPM D) GAM

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30) Because its payment stream looks like a staircase, which loan is sometimes referred to as "stepped-up" financing due to prearranged payment increases?

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A) CAM B) CPM C) GPM D) ARM

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31)

Demand for a mortgage loan is considered: A) stable demand B) derived demand C) interest rate demand D) nominal demand

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32)

Points are also known as: A) third party charges. B) reduction in payment amount. C) loan discount fees. D) reduction of mortgage yield.

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33)

APR stands for which of the following? A) Annual percentage rate B) Amortized percentage regulator C) Accrued percentage rate D) Annual percentage regulator

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34)

Assuming a constant APR the effective interest rate on a loan is highest when: A) the loan has no points and a 30-year maturity and is prepaid in five years. B) the loan has no points and is prepaid at maturity. C) points are charged and the loan is paid off at maturity in 30 years. D) points are charged and the loan has a 30-year maturity but is prepaid in five years.

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35)

Which one of the following is TRUE about prepayment penalties? A) They are never used with residential mortgages. B) They lower the effective cost if the loan is repaid before maturity. C) They are equivalent to charging additional points for the loan. D) They are not included in the APR calculation.

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36) If a fully amortizing 30-year fixed rate mortgage was originally taken at $200,000 with 5.25 percent interest, but now has a balance of $50,385, how many more monthly payments will it take before it will be paid off? A) 45 months B) 51 months C) 55 months D) 90 months

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37) What is the principal portion of the 222nd payment of a fully amortizing $250,000, 30year fixed rate loan with an interest rate of 4.825 percent?

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A) $562.38 B) $565.29 C) $753.07 D) $1,315.44

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38) What is the annual interest rate of a fully amortizing 20-year fixed rate $175,000 mortgage, with a monthly payment of $1,266.41? A) 5.10% B) 6.125% C) 6.25% D) 6.375%

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Answer Key Test name: Ch04 1) FALSE Inflation impacts the purchasing power of a currency and the return on investment, so it is a very important factor to buyers and lenders. 2) TRUE These are all important factors that impact the return to lenders and investors. 3) TRUE The key difference between the CAM and the CPM is the relationship of the loan amortization and interest paid. 4) TRUE With a CAM, the loan amortization and interest paid are directly related, so determining the loan balance is a simple present value of an annuity problem. 5) FALSE The effective and stated rates may be equal. 6) FALSE The Truth-in-Lending Act requires the lender must disclose to consumers the annual percentage rate (APR) being charged on the loan. 7) FALSE The APR does reflect inflation and other risks, which impact the true cost of funds. 8) FALSE It depends on the size of the prepayment penalty and the discount points. Version 1

9) FALSE Origination fees are not considered an interest expense and are not tax deductible for the borrower. 10) FALSE The objective of a GPM is to provide for a series of mortgage payments that are lower in the initial years of the loan than they would be with a standard mortgage loan. GPM payments then gradually increase at a predetermined rate as borrower incomes are expected to rise over time. 11) TRUE When actual inflation exceeds expected inflation, then the borrower has essentially borrowed at a lower rate. 12) FALSE The APR assumes the loan is repaid at maturity. 13) TRUE In a reverse mortgage, the borrower receives payments from the bank instead of receiving the full loan proceeds at closing. 14) FALSE Reverse mortgages are typically used by home-owning populations as they near retirement and seek ways to supplement their retirement income. 15) TRUE Unlike regular amortizing loans, a negative amortizing loan results in a higher balance at the end of the loan than originating loan balance. 16) C PMT(5%/12, 30 × 12, − 250,000,0) 17) B

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IPMT(5%/12, 1, 30 × 12, − 250,000,0) 18) D PMT(6%/12, 30 × 12, − 200,000,0) = − 1199.10 =FV(6%/12, 8 × 12, 1199.10, − 200,000) = 175,545 19) C One point equals .1%, so the effective rate is 6% + 0.4% = 6.4%. 20) A PMT(8%/12, 10 × 12, 0, − 150,000) 21) D Residential mortgage rates are impacted by factors that directly impact the residential home purchase market. Demand and supply of apartments do not directly impact the home purchase market. 22) C Liquidity, which is also known as marketability, and default are key risks to interest rates. 23) C Payments on CAMs are determined first by computing a constant amount of each monthly payment to be applied to principal or monthly amortization. Interest is then computed on the monthly loan balance and added to the monthly amount of amortization. The total monthly payment is determined by adding the constant amount of monthly amortization to interest on the outstanding loan balance. 24) C CPMs have a constant payment. As a result, the interest paid decreases over the life and the amortization increases. 25) B Version 1

The CPM carries a constant payment, whereas the CAM payment is determined by adding the constant amount of monthly amortization and the interest on the outstanding loan balance. Because the first month will have the highest outstanding loan balance, the CAM will have a higher first month payment than the CPM, all else held constant. 26) C A constant payment is the same as an annuity. 27) C Title insurance charges do not get paid to the lender, so this will not impact the lender’s effective loan yield. 28) C With the CPM, the constant payment is preferred when there is high inflation, because the borrower is has effectively locked in a lower rate than is the true rate of borrowing. During a recessionary period, the CAM is considered to be a very conservative loan structure because it places primary emphasis on the amortization of the loan. 29) A The CAM payment is determined by adding the constant amount of monthly amortization and the interest on the outstanding loan balance. The constant monthly amortization results in a continually lower principal balance. 30) C The objective of a GPM is to provide for a series of mortgage payments that are lower in the initial years of the loan than they would be with a standard mortgage loan. GPM payments then gradually increase at a predetermined rate as borrower incomes are expected to rise over time. 31) B

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The demand for mortgage loans is a derived demand because it is determined by the demand for real estate. 32) C Loan discount fees, or points, are charges that represent additional finance charges. 33) A The APR is the annual percentage rate of the loan. 34) D The effective interest rate includes the extra charge if any points are applied and if prepayment is included in the loan. 35) D Prepayment penalties may be used in residential mortgages, they increase the effective cost of the loan if it is repaid prior to maturity, and they are not included in the APR calculation. 36) B Part 1: N = 360; I/Y = 5.25%/12 = 0.4375%; PV = $200,000; FV = $0; CPT PMT = $1,104.41; Part 2: Change FV = −$50,385; CPT N = 309; Part 3: 360 − 309 = 51 months. 37) C Part 1: N = 360; I/Y = 4.825%/12 = 0.4021%; PV = $250,000; FV = 0; CPT PMT = $1,315.44; Part 2: N = (360 − 221 = 139); CPT PV = $139,865.75 (loan balance after 221 payment); Part 3: $139,865.75 × 0.00421 = $562.38 (this is the interest portion of the 222nd payment); Part 4: $1,315.44 − $562.38 = $753.07 (Principal portion of the 222nd payment) Version 1

38) B N = 240; PV = $175,000; PMT = −$1,266.41; FV = $0; CPT I/Y = 0.5104% × 12 = 6.125%

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) ARMs were developed because lenders were tired of offering a limited selection of loan alternatives to borrowers. ⊚ true ⊚ false Question Details Topic : ARMs Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

2) ARMs help lenders combat unanticipated inflation changes, interest rate changes, and a maturity gap. ⊚ true ⊚ false Question Details Topic : ARMs Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

3) Characteristics of a PLAM include an increasing mortgage payment and an adjusting loan balance tied to an index. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : PLAMs Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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4) A major benefit of a PLAM is that the mortgage payment increases are tied to increases in the borrower’s salary. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : PLAMs Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

PLAMs have been very popular with lenders. ⊚ true ⊚ false

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6) Lenders can partially avoid estimating interest rates by tying an ARM to an interest rate index. ⊚ true ⊚ false Question Details Topic : ARMs Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

Negative amortization reduces the principal balance of a loan. ⊚ true ⊚ false

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The floor of an ARM is the maximum reduction of payments or interest rates allowed. ⊚ true ⊚ false

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ARMs eliminate all the lender’s interest rate risk. ⊚ true ⊚ false

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10)

The default risk of an FRM is higher than the default risk of an ARM. ⊚ true ⊚ false

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11)

An ARM may also be referred to as a floating payment loan. ⊚ true ⊚ false

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12) A borrower with an interest-only loan may end up owing more at the end of the loan than the original loan amount. ⊚ true ⊚ false Question Details Topic : ARMs Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 13) A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a "teaser" rate of 4 percent, after that the rate can reset with a 2 percent annual rate cap. On the reset date, the composite rate is 5 percent. What would the Year 3 monthly payment be?

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A) $955 B) $1,067 C) $1,071 D) $1,186

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14) A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a "teaser" rate of 4 percent, after that the rate can reset with a 5 percent annualpayment cap. On the reset date, the composite rate is 6 percent. What would the Year 3 monthly payment be?

A) $955 B) $1,067 C) $1,003 D) $1,186

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15) A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a "teaser" rate of 4 percent, after that the rate can reset with a 5 percent annualpayment cap. On the reset date, the composite rate is 6 percent. Assume that the loan allows for negative amortization. What would be the outstanding balance on the loan at the end of Year 3?

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A) $190,074 B) $192,337 C) $192,812 D) $192,926

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16)

Which is NOT a component of an ARM? A) A margin B) An index C) A chapter D) Caps

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17) Which of the following descriptions most accurately reflects the risk position of an ARM lender in comparison to that of an FRM lender?

(A) (B) (C)

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Interest Rate Risk Higher Lower Higher

Default Risk Higher Lower Lower

(D)

Lower

Higher

A) Option A B) Option B C) Option C D) Option D

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18) LOAN 1 Initial Interest Rate Loan Maturity (years) % Margin Above Index Adjustment Interval Points Interest Rate Cap

? 20 3% 1 year 1% NONE

LOAN 2 ? 20 — — 1% —

LOAN 3

LOAN 4

? 20 3% 1 year 1% 1%/year

? 20 3% 1 year 1% 3%/year

Which loan in the above table should have the lowest initial interest rate? A) Loan 1 B) Loan 2 C) Loan 3 D) Loan 4

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19) LOAN 1 Initial Interest Rate Loan Maturity (years) % Margin Above Index Adjustment Interval Points Interest Rate Cap

? 20 3% 1 year 1% NONE

LOAN 2 ? 20 — — 1% —

LOAN 3

LOAN 4

? 20 3% 1 year 1% 1%/year

? 20 3% 1 year 1% 3%/year

Which loan in the above table is an FRM? A) Loan 1 B) Loan 2 C) Loan 3 D) Loan 4

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20)

Initial Interest Rate Loan Maturity (years)

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LOAN 1

LOAN 2

LOAN 3

LOAN 4

? 20

% Margin Above Index Adjustment Interval Points Interest Rate Cap

3% 1 year 1% NONE

— — 1% —

3% 1 year 1% 1%/year

3% 1 year 1% 3%/year

With which loan in the above table does the lender have the lowest interest rate risk? A) Loan 1 B) Loan 2 C) Loan 3 D) Loan 4

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21)

Under which scenario is negative amortization likely to occur? Payment Cap None None 7.5% 7.5%

(A) (B) (C) (D)

Interest Rates Increasing Decreasing Increasing Decreasing

A) Option A B) Option B C) Option C D) Option D

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22)

In order to calculate the APR for an ARM, you must:

A) only use the first year’s given interest rate. B) estimate interest rates over the life of the loan. C) assume the worst case scenario and use interest rates at their highest possible point over the life of the loan. D) use only the first five years' interest rates because they can easily be estimated and most people only own a property for five years.

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23) If an ARM index increased 15 percent, the negative amortization on a loan with a 5 percent annual payment cap is calculated by:

A) using the same payment as last year and deducting 5 percent from the principal balance. B) increasing the payment by 5 percent. C) totaling the difference between the payments with the 5 percent capped payment. D) compounding the difference between the payments as if no cap existed and with the 5 percent capped payment.

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24) If one of the terms of an ARM read “interest is capped at 2%/5%”, what would that mean?

A) The borrower can choose the cap he wants by circling the appropriate choice. B) The interest rate has a 2 percent annual cap rate and a 5 percent lifetime cap rate. C) The interest rate has a 5 percent annual cap rate and a 2 percent lifetime cap rate. D) The interest rate has a 2 percent annual cap rate and a 5 percent floor cap rate.

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25)

Which of the following is a disadvantage of PLAMs? A) Lenders face high levels of interest rate risk under PLAMs. B) Fewer homebuyers are likely to qualify for financing using PLAMs in comparison to

CPMs. C) The price level used to index PLAMs is measured on an ex post basis and historic prices may not be an accurate reflection of future price. D) All of the choices are disadvantages.

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26)

Which of the following clauses leads to higher risk for an ARMs lender?

A) Negative amortization is not allowed when interest is not covered by the payment due to a payment cap. B) There is a floor for payments. C) The adjustment interval is longer than one year. D) All of the clauses lead to higher risk for an ARMs lender.

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27)

The expected cost of borrowing depends on which of the following provisions? A) The frequency of payment adjustments B) The inclusions of caps and floors on the interest rate, payment, or loan balances C) The spread over the index chosen for a given ARM D) All of the choices are correct.

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28) Given that every other factor is equal, which of the following ARMs will have the lowest expected cost? A) An ARM with payment caps and negative amortization B) An ARM with interest rate caps C) An ARM with a longer adjustment interval D) An ARM with no caps or limitations

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29)

What is the meaning of “interest is capped at 2%/5%”?

A) The loan has a 2 percent annual cap rate and a 5 percent lifetime cap rate. B) The borrower can choose the cap he wants by circling the appropriate choice. C) The loan has a 2 percent lifetime cap rate and a 5 percent annual cap rate. D) The loan has a 2 percent annual cap rate and a 5 percent floor cap rate.

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30) A borrower takes a 30-year fully amortizing 5/1 ARM for $225,000 with an initial interest rate of 4.375 percent. Assuming the index on which the loan rate is based rises by 1 percent in the fourth year of the loan and remains at that level, what will the payment be in the sixth year of loan?

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A) $1,123.39 B) $1,241.89 C) $1,259.94 D) $1,403.71

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Answer Key Test name: Ch05 1) FALSE ARMs developed as a way for the lenders and borrowers to share the risk of interest rate changes. 2) TRUE Rather than making mortgages with fixed rates of interest over long periods of time, ARMs provide an alternative method of financing through which lenders and borrowers share the risks, including the changing inflation and interest rate risks that occur after origination of the loan and before maturity. 3) TRUE The PLAM loan balance is adjusted by a price index that is tied to changing inflation and risks. 4) FALSE One major risk is that the increasing payments may not be accompanied by increasing salaries, as salaries may not directly reflect inflation changes. 5) FALSE PLAMs still leave lenders at risk due to changes in the expected real rate of interest and the risk premium, making them unpopular with lenders. 6) TRUE By tying an ARM to an index, the lender can partially avoid the need to correctly estimate the interest rate since changes in the index will be reflected in the ARM.

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7) FALSE Negative amortization increases the principal balance of the loan. 8) TRUE Maximum reductions in payments or interest rates on reset dates are called floors. 9) FALSE ARMs allow the lender to share the risk with the borrower but does not fully eliminate the risk to the lender. 10) FALSE Because ARMs may result in higher payments as interest rates increase, the ARM carries a higher default risk than the FRM. 11) FALSE An ARM that is used to finance a commercial property is sometimes called a floating rate loan. 12) FALSE With an interest-only loan, Monthly payment = Loan amount * (Interest rate ÷ 12), so the borrower will not owe more than the original amount. 13) B Step 1: Find the payment at 4 percent for the first two years: =PMT(0.04/12,30*12,-200000) = $954.83. Next, find the value of the outstanding loan balance at the end of the second year: =FV(0.04/12,2*12,954.83,-200000) = $192,812.36. Finally, find the loan payments at the rate of 6 percent; =PMT(0.06/12,28*12,192812.36) = $1,067. 14) C

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Step 1: Find the payment at 4 percent for the first two years: =PMT(0.04/12,30*12,-200000) = $954.83. Next, find the value of the outstanding loan balance at the end of the second year: =FV(0.04/12,2*12,954.83,-200000) = $192,812.36. Finally, find the loan payments at the rate of 5 percent; =PMT(0.05/12,28*12,192812.36) = $1,067. Since this is more than a 5 percent increase in the payment amount, this cannot be the new payment. The new payment will be limited to $954.83 x 1.05 = $1,003. 15) B Step 1: Find the payment at 4 percent for the first two years: =PMT(0.04/12,30*12,-200000) = $954.83. Next, find the value of the outstanding loan balance at the end of the second year: =FV(0.04/12,2*12,954.83,-200000) = $192,812.36. Finally, find the loan payments at the rate of 5 percent; =PMT(0.06/12,28*12,-192812.36) = $1,186.04. Since this is more than a 5 percent increase in the payment amount, this cannot be the new payment. The new payment will be limited to $954.83 x 1.05 = $1,003. To find the balance at the end of Year 3, we use the lower payment amount: =FV(0.06/12,12,-1003,192812.36,) = $192,337. 16) C The components of an ARM may include the margin, an index with which the rate is tied, and caps. A chapter is not an ARM element. 17) D

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With an ARM, the lender is able to share the interest rate risk with the borrower, so this risk is lower than with an FRM; however, the potential increase in the payment of an ARM makes the risk of default by the borrower higher than as is present with an FRM. 18) A The loan that shifts the most risk to the borrower should have the lower initial interest rate. Since Loan 1 has no interest rate cap and is adjusted to an index, it is riskier than the others. 19) B Since Loan 2 does not adjust according to an index, it represents a fixed rate mortgage. 20) A Since there is no interest rate cap with Loan 1, it has the least interest rate risk for the lender. 21) C When there is a payment cap and increasing interest rates, the loan balance may increase by an even greater amount because of more accrued interest. When this occurs, there is negative amortization. 22) C Because the interest rates of an ARM changes over time, the worst case scenario (and, thus, highest interest rate) should be assumed in calculating the APR. 23) D The negative amortization on a loan with a cap that is lower than the index would be based on the sum of the difference between the payments with the capped percentage applied. 24) B Version 1

A term of “2%/5%” implies an annual cap of the numerator term (2%), with a lifetime cap of the denominator term (5%). 25) C A key disadvantage of a PLAM is that it uses historical price levels as the index and future price levels may be higher due to increased inflation and other risks. 26) C An adjustment interval of greater than one year means that the lender may not be able to react to increases in interest rates. 27) D The expected costs of borrowing are impacted by the frequency of payment adjustments, inclusions of caps and floors, and the spread versus the designated index. 28) D The lack of caps or limitations shifts more risk to the borrower, so this type of loan would be expected to have a lower cost. 29) A A term of “2%/5%” implies an annual cap of the numerator term (2%), with a lifetime cap of the denominator term (5%). 30) B N = 360; I/Y = 4.375%/12 = 0.3646%; PV = $225,000; FV = $0; CPT PMT = $1,123.39 N = 360 − 60 = 300; CPT PV = $204,714.11 I/Y = 5.375%/12 = 0.4479%; CPT PMT = $1,241.89

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) A borrower finds that the incremental cost of borrowing an extra $10,000 is 14 percent. The borrower can earn 12 percent on alternative investments of comparable risk so he would be better off by not borrowing the extra 14 percent. ⊚ ⊚

true false

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2) A borrower finds that the incremental cost of borrowing an extra $10,000 is 14 percent. A second loan can be obtained at 15 percent so the borrower would be better off borrowing a smaller amount on the original loan and borrowing $10,000 with a second loan. ⊚ ⊚

true false

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3) The cash equivalent value of a house that sold with favorable financing is usually less than its sale price. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Cash Equivalency Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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4) The effective cost of a wraparound loan should be comparable to the cost of a second mortgage with the same loan-to-value ratio. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Wraparound Loans Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

5) A borrower is considering refinancing and finds that the return, considering refinancing charges and lower payments, is 10 percent. The borrower can earn 12 percent on alternative investments so the property should be refinanced. ⊚ ⊚

true false

Question Details Topic : Refinancing Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

6) Homeowners should not borrow refinancing costs because the effective rate of refinancing will be higher. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Refinancing Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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If interest rates decrease, the market value of a loan previously made will increase. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Market Value of a Loan Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

8) A house that is financed with a below-market loan is available for sale. The value of the house will be higher than similar properties regardless of the other terms of the loan. ⊚ true ⊚ false Question Details Topic : Market Value of a Loan Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

9) A potential buyer is interested in purchasing a home that has an assumable below-market loan. The buyer determines that the financing premium associated with the below-market loan is worth $4,300. If similar houses sell for $100,000, the buyer should be willing to pay $104,300 or more for the property. ⊚ true ⊚ false Question Details Topic : Market Value of a Loan Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

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10) Buydown loans have initial payments that are lower than they would be without the buydown provision. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Buydowns Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

11) A loan with biweekly payments will have more interest than a monthly loan with the same interest rate and loan term. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Refinancing Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

12)

Home equity loans do not require a mortgage lien on the property. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Second Mortgages Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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13) The incremental cost of borrowing may also be referred to as the marginal cost of borrowing. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Incremental Borrowing Costs Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

14) The primary benefit of choosing biweekly mortgage payments versus monthly payments is the savings from lowering the average amount paid each month. ⊚ true ⊚ false Question Details Topic : Biweekly Payments Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 15) A house is for sale for $250,000. You have a choice of two 20-year mortgage loans with monthly payments: (1) if you make a down payment of $25,000, you can obtain a loan with a 6 percent rate of interest or (2) if you make a down payment of $50,000, you can obtain a loan with a 5 percent rate of interest. What is the effective annual rate of interest on the additional $25,000 borrowed on the first loan?

A) 1.00% B) 6.00% C) 12.95% D) 18.67%

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Question Details Topic : Incremental Borrowing Costs Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

16) A borrower has secured a 30-year, $150,000 loan at 7 percent with monthly payments. Fifteen years later, the borrower has the opportunity to refinance with a fifteen year mortgage at 6 percent. However, the upfront fees, which will be paid in cash, are $2,500. What is the return on investment if the borrower expects to remain in the home for the next fifteen years?

A) 6.00% B) 13.00% C) 22.62% D) 28.89%

Question Details Topic : Refinancing Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

17) A borrower has secured a 30-year, $150,000 loan at 7 percent with monthly payments. Fifteen years later, an investor wants to purchase the loan from the lender. If market interest rates are 5 percent, what would the investor be willing to pay for the loan?

A) $75,000 B) $111,028 C) $126,196 D) $168,646

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Question Details Topic : Refinancing Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

18) Which of the following statements concerning a 30-year, $150,000 loan at 7 percent with monthly payments is true if, 15 years later, an investor wants to purchase the loan and market interest rates are 5 percent?

A) The market value of the loan is higher than the book value of the loan because the market rate of interest is lower than the interest rate on the loan. B) The market value of the loan is lower than the book value of the loan because the market rate of interest is lower than the interest rate on the loan. C) The market value of the loan is higher than the book value of the loan because the market rate of interest is higher than the interest rate on the loan. D) The market value of the loan is lower than the book value of the loan because the market rate of interest is higher than the interest rate on the loan.

Question Details Topic : Market Value of a Loan Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

19) A borrower is purchasing a property for $180,000 and can choose between two possible loan alternatives. The first is a 90 percent loan for 25 years at 9 percent interest and 1 point and the second is a 95 percent loan for 25 years at 9.25 percent interest and 1 point. Assuming the loan will be held to maturity, what is the incremental cost of borrowing the extra money?

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A) 13.66% B) 13.50% C) 14.34% D) 12.01%

20) A borrower is purchasing a property for $180,000 and can choose between two possible loan alternatives. The first is a 90 percent loan for 25 years at 9 percent interest and 1 point and the second is a 95 percent loan for 25 years at 9.25 percent interest and 1 point. Assuming the loan will be repaid in 5 years, what is the incremental cost of borrowing the extra money?

A) 13.95% B) 13.67% C) 14.42% D) 12.39%

Question Details Topic : Incremental Borrowing Costs Difficulty : 3 Hard Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

21) When purchasing a $210,000 house, a borrower is comparing two loan alternatives. The first loan is a 90 percent loan at 10.5 percent for 25 years. The second loan is an 85 percent loan for 9.75 percent over 15 years. Both have monthly payments and the property is expected to be held over the life of the loan. What is the incremental cost of borrowing the extra money?

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A) 20.25% B) 16.17% C) 11.36% D) 12.42%

22) A borrower made a mortgage loan 7 years ago for $160,000 at 10.25 percent interest for 30 years. The loan balance is now $151,806.62 and rates for this amount are currently 9.0 percent for 23 years. Origination fees and closing costs are $4,500, and closing costs are not financed by the lender. What is the effective cost of refinancing?

A) 9.00% B) 10.85% C) 15.32% D) 9.39%

Question Details Topic : Refinancing Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

23) Mr. Tramp made a mortgage 5 years ago for $85,000 at 8.25 percent interest and a 15year term. Rates have now risen to 10 percent for an equivalent loan. Mr. Tramp's lender is willing to discount the loan by $2,000 if he will prepay the loan. What rate of return would Mr. Tramp receive by prepaying the loan?

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A) 10.24% B) 8.95% C) 14.32% D) 9.14%

Question Details Difficulty : 2 Medium Topic : Early Loan Repayment Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

24) A loan was made 10 years ago for $140,000 at 10.5 percent for a 30-year term. Rates are currently 9.25 percent. What is the market value of the loan?

A) $128,271 B) $147,600 C) $139,828 D) $151,395

Question Details Topic : Market Value of a Loan Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

25) Bud is offering a house for sale for $180,000 with an assumable loan which was made 5 years ago for $140,000 at 8.75 percent over 30 years. Kelsey is interested in buying the property and can make a $20,000 down payment. A second mortgage can be obtained for the balance at 12.5 percent for 25 years. What is the effective cost of the combined loans that Kelsey can use to compare this financing alternative to obtaining a first mortgage for the full amount?

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A) 10.63% B) 9.39% C) 9.04% D) 11.27%

Question Details Difficulty : 3 Hard Topic : Refinancing Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

26) A house is sold with an assumable $156,000 below-market loan at 8.5 percent for a remaining term of 15 years. Current rates are 9.75 percent for 15-year mortgages. If the house sold for $240,000, what is the cash-equivalent value of the house?

A) $250,834.82 B) $229,011.12 C) $260,660.40 D) $219,339.60

Question Details Topic : Cash Equivalency Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

27) Ms. Madison has an existing loan with payments of $782.34. The interest rate on the loan is 10.5 percent and the remaining loan term is 10 years. The current balance of the loan is $57,978.99. The home is now worth $120,000 and Ms. Madison would like to borrow an additional $30,000 through a wraparound loan which would increase the debt to $87,978.99. Terms of the wraparound loan are 12.25 percent interest with monthly payments for 10 years. What is the incremental cost of borrowing the extra $30,000 through a wraparound loan?

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A) 15.47% B) 11.38% C) 12.96% D) 13.41%

Question Details Topic : Wraparound Loans Difficulty : 3 Hard Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

28) Mr. Fisher has built several houses and is offering buyers mortgage rates of 10 percent with a 15-year term. Current rates are 10.75 percent. Fourth National Bank will provide the loans if Mr. Fisher pays an equivalent amount up front to buy down the interest rate. If a house is sold for $290,000 with a 90 percent loan, how much would Mr. Fisher have to pay to buy down the loan?

A) $1,957.50 B) $11,989.34 C) $11,250.25 D) $10,790.41

Question Details Topic : Buydowns Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

29) When calculating the cash equivalent value of an assumable loan, you find the present value of the payments using the:

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A) contract interest rate. B) incremental borrowing cost. C) market interest rate. D) discount rate.

Question Details Difficulty : 1 Easy Topic : Cash Equivalency Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

30)

Which of the following is TRUE concerning wraparound Loans? A) The borrower makes payments on an existing loan. B) The lender makes payments on an existing loan. C) The lender only makes payments on the second mortgage. D) The borrower only makes payments on the second mortgage.

Question Details Difficulty : 1 Easy Topic : Wraparound Loans Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

31)

Which of the following is FALSE concerning buydown loans? A) They are often used during periods of high inflation. B) They always lower the rate on the loan for the borrower for the entire loan term. C) They help borrowers qualify for a loan. D) They can be offered by home builders.

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Question Details Difficulty : 1 Easy Topic : Buydowns Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

32)

Which of the following is TRUE regarding the incremental cost of borrowing? A) It should be less than the rate for a first mortgage. B) It should be compared to the cost of obtaining a second mortgage. C) It is used to calculate the APR for the loan. D) It is independent of the loan-to-value ratio.

Question Details Difficulty : 1 Easy Topic : Incremental Borrowing Costs Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

33)

The market value of a loan is the: A) loan balance times one minus the market rate. B) loan balance times one minus the original rate. C) future value of the remaining payments. D) present value of the remaining payments.

Question Details Difficulty : 1 Easy Topic : Market Value of a Loan Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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34)

Which of the following is an important aspect of the loan refinance decision process? A) Terms associated with the existing loan B) Terms of the new loan C) Fees associated with paying off the old loan and/or acquiring the new loan D) All of the choices are correct.

Question Details Difficulty : 1 Easy Topic : Refinancing Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

35) Ms. Towne is buying a home for $250,000 and is putting down 20 percent cash on the purchase. She is financing the rest with a 30-year, fixed rate mortgage with a rate of 4.625 percent, but is considering an option that would allow her to make biweekly payments. How much interest would the biweekly payment option allow her to save over the life of the loan and how long would it take to pay off the loan?

A) $29,528; 25.5 years B) $33,234; 22.2 years C) $29,528; 22.2 years D) $33,234; 25.5 years

Question Details Difficulty : 3 Hard Topic : Biweekly Financing Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

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Answer Key Test name: Ch06 1) TRUE It is not beneficial to borrow at a higher rate than you can earn on alternative investments. 2) FALSE The borrower is better off borrowing at a lower rate. 3) TRUE The sale price includes the cash equivalent value and the financing premium, so it is higher than the cash equivalent value. 4) TRUE Wraparound loans are used to obtain additional financing on a property while keeping an existing loan in place. The wraparound lender makes a loan for a face amount equal to the existing loan balance plus the amount of additional financing, so the effective cost should be the same as that of a second mortgage, all else held constant. 5) FALSE Since the borrower can earn a higher return with alternative investments versus refinancing, then the borrower should not refinance. 6) FALSE Homeowners will benefit if they are able to borrow refinancing costs at a lower interest rate than the effective rate of refinancing. 7) TRUE

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Decreasing interest rates will increase the market value of the loan. To find the market value of a loan, you simply calculate the present value of the remain¬ing payments at the market rate of interest. 8) FALSE The other terms of the loan matter and may make the value of the house lower versus other properties. 9) FALSE The amount the buyer should pay is based on the cash equivalent value which includes the interest rate inherent on the assumable loan. 10) TRUE With a buydown loan, the seller of the property (frequently a builder) pays an amount to a lender to buy down, or lower, the interest rate on the loan for the borrower for a specific period of time. 11) FALSE Biweekly payments may lower the amount of interest over the life of the loan and repay the loan sooner. 12) FALSE Home equity loans provide the lender with a second mortgage lien on the property. 13) TRUE Incremental cost is the extra or marginal cost of borrowing. 14) FALSE Benefits include the lower total interest paid over life of loan and the earlier payoff of the loan. The average amount paid on a monthly basis is the same as with monthly payments. 15) C PV

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225000

200000 17

Rate NPER PMT PV

6% 240 ($ 1,611.97) 25000

PMT

($ 292.06)

NPER

240 1.08%

5% 240 ($ 1,319.91)

per month

12.95%

16) D

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Step 1: Find the monthly payment for the first 15 years: = PMT(0.07/12,30 × 12,−150000) = $997.95. Step 2: Find the loan balance at the end of 15 years: = FV(0.07/12,15 × 12,997.95,−150000) = $111,028.30. Step 3: Find the monthly payment assuming the refinanced rate: = PMT(0.06/12,15 × 12,−111028.30) = $936.92. Step 4: Find the difference between the original monthly payments and the refinanced payments: = $997.95 − $936.92 = $61.03. Step 5: Calculate the monthly return on this payment difference: = RATE(15 × 12,61.03,−2500) = 0.0241, or 2.41%. Step 6: Calculate the annual return: 2.41% × 12 = 28.89%. 17) C Step 1: Find the monthly payment for the first 15 years: = PMT(0.07/12,30 × 12,−150000) = $997.95. Step 2: Find the present value assuming these payments at the new market rate: = PV(0.05/12,15 × 12,−997.95) = $126,196.48. 18) A

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When the market rate of interest decreases, the market value of the loan made at the higher rate will be higher than the book value of the loan. 19) A PV Rate NPER PMT PV Rate NPER PMT

171000 9.25% 300 ($1,464.41) 169290 9.25% 300 ($1,464.41)

8910

PMT

($104.91)

NPER

300 1.14%

162000 9.00% 300 ($1,359.50) 160380 9.00% 300 ($1,359.50)

per month

13.66%

20) A PV Rate NPER PMT PV Rate NPER PMT PV Rate NPER PMT FV PV PMT NPER

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171000 9.25% 300 ($1,464.41) 169290 9.25% 300 ($1,464.41) 171000 9.25% 60 ($1,464.41) $159,893.65

162000 9.00% 300 ($1,359.50) 160380 9.00% 300 ($1,359.50) 162000 9.00% 60 ($1,359.50) $151,101.35 8910 ($104.91) 60

FV RATE

$8,792.30 1.16%×12=13.95%

21) D Loan Value

Payments Years 1-15

Payments Years 16-25

Loan 1: 90% =210000*0.9 =PMT(0.105/12,25*12,- =PMT(0.105/12,25*12,@ 10.5%, 25 189000) 189000) years Loan 2: 85% =210000*0.85 =PMT(0.0975/12,15*12,0 @ 9.75%, 15 178500) years Difference = $10,500 = –$106.46 = $1,784.50 Requires cash flow analysis: CF0 = CFj = nj = CFj = nj =

–$ 10,500 –$ 106.46 180 (Years 1–15) $ 1,784.50 120 (Years 16–25)

Solve for IRR: (monthly) = 1.03% (annualized) = 12.42% 22) D Step 1: Calculate the value of the loan minus the refinancing costs: $151,806.62 − $4,500 = $147,306.62. Step 2: Calculate the value of the loan payment under the refinanced terms: = PMT(0.09/12,23 × 12,−151806.62) = $1,304.43. Step 3: Calculate the rate: = RATE(23 × 12,1304.43,−147306.62) = 0.78% × 12 = 9.39%. 23) B

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Step 1: Calculate the monthly payment: = PMT(0.0825/12,15 × 12,−85000) = $824.62. Step 2: Calculate the loan balance today: = FV(0.0825/12,5 × 12,824.62,−85000) = $67,232.10. Step 3: Calculate the amount of loan that would need to be paid back, considering the incentive: $67,232.10 - $2,000 = $65,232.10. Step 4: Calculate the rate of return of prepaying today = RATE(10 × 12,824.62,−65232.10) = 0.75% × 12 = 8.95%. 24) C Step 1: Find the monthly payment on the original loan: = PMT(0.105/12,30 × 12,−140000) = $1,280.64. Step 2: Find the market value of the loan by discounting the remaining payments at the market rate: = PV(0.0925/12,20 × 12,−1280.64) = $139,827.64. 25) B

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Step 1: Calculate the original loan monthly payment: = PMT(0.0875/12,30 × 12,−140000) = $1,101.38. Step 2: Calculate the loan balance at time of offer for sale: = FV(0.0875/12,5 × 12,1101.38,−140000) = $133,964.49. Step 3: Calculate the value of the second mortgage: $180,000 new price − $20,000 down payment = $160,000. Then, subtract the outstanding loan balance from the owner’s original mortgage = $160,000 − $133,964.49 = $26,035.51. Step 4: Calculate the monthly payment for the second mortgage: = PMT(0.125/12,25 × 12,−26035.51) = $283.88 and add this to the original loan payment to get the total monthly payment = $1,101.38 + $283.88 = $1,385.26. Step 5: Calculate the effective cost of the combined loans: = RATE(25 × 12,1385.26,−160000) = 0.78% × 12 = 9.39%. 26) B Step 1: Calculate the monthly payment on the assumable loan: = PMT(0.085/12,15 × 12,−156000) = $1,536.19. Step 2: Calculate the value of the loan at the current market rates: = PV(0.0975/12,15 × 12,−1536.19) = $145,011.12. Step 3: Determine the difference between the assumable loan and the current value at market rates: $156,000 − $145,011.12 = $10,988.88. Step 4: Calculate the cash-equivalent value of the house: $240,000 − $10,988.88 = $229,011.12. 27) A Version 1

Step 1: Calculate the monthly payment for the wraparound loan: = PMT(0.1225/12,10 × 12,−87978.99) = $1,274.99. Step 2: Calculate the difference between the wraparound loan payment and the existing loan payment: = $1,274.99 − $782.34 = $492.65. Step 3: Calculate the incremental cost of borrowing the extra $30,000: =RATE(10 × 12,492.65,−30000) = 1.29% × 12 = 15.47%. 28) D Step 1: Calculate the amount of the loan: $290,000 × 90% = $261,000. Step 2: Calculate the monthly loan payment assuming the market rate: = PMT(0.1075/12,15 × 12,−261000) = $2,925.67. Step 3: Calculate the monthly loan payment assuming the seller’s terms: = PMT(0.1/12,15 × 12,−261000) = $2,804.72. Step 4: Calculate the difference in monthly payments: $2,925.67 − $2,804.72 = $120.95. Step 5: Calculate the buydown payment: = PV(0.1075/12,15 × 12,−120.95) = $10,790.41. 29) C The market interest rate should be used to calculate the cash equivalent value. 30) B

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Wraparound loans are used to obtain additional financing on a property while keeping an existing loan in place. The wraparound lender makes a loan for a face amount equal to the existing loan balance plus the amount of additional financing. 31) B Buydown loans may carry terms that only lower the rates for a set period of time that does not extend for the full loan term. 32) B To determine whether incremental borrowing is beneficial, the cost of the borrowing should be compared to the cost of a second mortgage. 33) D The market value of an existing loan is determined by calculating the present value of the payments that remain to fulfill the loan terms. 34) D The entire cost of refinancing should be considered. This includes the existing loan terms, the new loan terms, and the fees associated with closing the old loan and originating the new loan. 35) A Monthly payment = $1,028.28; Total pmts = $370,180; Total Int: $170,180 Biweekly payment = $1,028.28/2 = $514.14 I/Y = 4.625%/26 annual pmts = 0.1179%; PV = $200,000; PMT = $514.14; FV = $0; CPT N = 662.57 biweekly payments / 26 periods per year = 25.5 years. 662.57 payments * $514.14 payment = $340,652; Total int: $140,652 $170,180 − $140,652 = $29,528 Total interest savings

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) If the cost of rental housing increases relative to house prices, demand for purchased housing tends to increase. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Topic : House Price Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

If mortgage interest rates increase, demand for purchased housing tends to increase. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Topic : House Price Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

3) Cluster analysis using location quotients and/or employment multipliers provides a snapshot of employment at a point in time but does not provide a forecast of future employment in a specific industry. ⊚ true ⊚ false Question Details Topic : Economic Base Analysis Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

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4) One concern of appraisers when using the sales comparison approach is that financing benefits paid for by a seller of a property may result in a selling price for the comparable property that is lower than the market value. ⊚ true ⊚ false Question Details Topic : Appraisals Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

A housing bubble occurs when there is a big increase in the supply of homes. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Housing Supply Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

Use of construction costs is very important in the sales comparison approach to valuation. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Appraisals Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

7) Mortgage interest and property taxes are deductible for federal income tax purposes for homeowners.

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⊚ ⊚

true false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Topic : House Price Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

8) When the value of public goods exceeds their cost, the effect on house prices is called the "capitalization effect." ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Housing Supply Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Topic : House Pricing Gradable : automatic

9) Population increases are usually associated with increases in demand and house price appreciation. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Topic : House Price Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

10) It is likely that two identical houses located in different school districts will sell for different prices.

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⊚ ⊚

true false

Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Topic : House Price Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

11) Estimating the land value for an improved property cannot be accomplished using the sales comparison method of valuation. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Appraisals Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

12) When using the cost approach to valuation, current market data for land values must be obtained. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Appraisals Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

13) The appraisal function is purely objective; an appraiser's judgment is not part of the decision process. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : Appraisals Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

14) Residential appraisers use only the sales comparison approach to determine value of the homes they appraise. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Appraisals Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

15) Housing futures contracts allow investors to speculate on changes in home prices without actually owning a home. ⊚ true ⊚ false Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Topic : House Price Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

16)

A location quotient is the ratio of total employment to base employment. ⊚ true ⊚ false

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Question Details Topic : Economic Base Analysis Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

17) Comparable properties must be chosen from those homes that have been sold or have been listed for sale most recently, and that are located in the same city as the subject property. ⊚ ⊚

true false

Question Details Topic : Appraisals Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

18) Potential investors, in analyzing the profit potential for a distressed property, generally consider a financial framework including the acquisition phase, the holding period phase, and the disposition phase. ⊚ ⊚

true false

Question Details Difficulty : 1 Easy Topic : Investing in "Distressed Properties" Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 19) Assume that houses in an area appreciate at the rate of 4 percent a year. A borrower expects to have a loan-to-value ratio of 90 percent. What is the approximate expected appreciation rate on home equity?

A) 4.0% B) 10% C) 20% D) 40%

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20)

Which of the following statements best describes the "wealth effect"?

A) Households with equity in their houses are wealthier than households that rent their housing. B) Expected appreciation in assets, such as home equity, may increase spending on other goods and services in the economy. C) Economists believe that wealthier households have a positive effect on the housing market, while low-income households have a negative effect. D) A 10 percent increase in homeownership is associated with a 12 percent increase in economic growth.

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21) A property is purchased for $200,000 with an 80 percent LTV. After five years, the owner's equity is $80,000. What would be the approximate annual expected appreciation rate on home equity?

A) 13.9% B) 14.9% C) 20.0% D) 80.0%

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22)

A region has a location quotient of 0.5 for manufacturing. This means that:

A) the region’s share of employment in manufacturing is twice as large as the share of manufacturing employment in the U.S. B) the region’s share of employment in manufacturing is half as large as the share of manufacturing employment in the U.S. C) manufacturing is a "base" or "driver" industry for the region D) both the region's share of employment in manufacturing is twice as large as the share of manufacturing employment in the U.S. and manufacturing is a "base" or "driver" industry for the region. E) both the region's share of employment in manufacturing is half as large as the share of manufacturing employment in the U.S. and manufacturing is a "base" or "driver" industry for the region.

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Question Details Topic : Economic Base Analysis Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

23)

The capitalization effect:

A) is one of the major factors leading to housing bubbles. B) has no impact on housing prices. C) relates the quality of public services that individuals receive relative to the taxes that are paid for the services. D) relates the interest rate on mortgage loans to the value of residential real estate.

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24)

The objective of an appraisal is to:

A) establish the highest possible price that a property can sell for. B) establish the most probable price that would be paid for a property under competitive market conditions. C) establish the market value for a property’s land without any structures (such as a house). D) establish the market value for a property if the property is put to its highest and best use.

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Question Details Difficulty : 1 Easy Topic : Appraisals Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

25) An appraisal usually contains three approaches to valuation. Which of the following is NOT one of those approaches? A) The market approach B) The ratio approach C) The cost approach D) The income approach

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26) The subject property of an appraisal has only two bedrooms, but one of the comparables used in the appraisal has three bedrooms. If the adjustment for a third bedroom is $5,000, the adjustment would be:

A) a $5,000 increase to the comparable's selling price. B) a $5,000 decrease to the comparable's selling price. C) a $5,000 increase to the subject's selling price. D) a $5,000 decrease to the subject's selling price.

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Question Details Topic : Appraisals Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

27)

The appraised value of a property usually represents the: A) actual value of the property. B) actual selling price of the property. C) actual opinion of an appraiser. D) actual replacement value of the property.

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28) When considering the federal income tax treatment for housing, which of the following is tax deductible? A) Mortgage principal and interest paid B) Mortgage interest paid C) Homeowner's insurance paid D) Mortgage principal paid

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29) When calculating taxes, the difference between the acquisition cost and selling price of a house is called: A) ordinary income. B) amortization. C) capital gain. D) deferred income.

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30)

Which of the following would NOT result in an increase in housing demand? A) Population growth B) Employment growth C) Higher interest rates D) Higher household income

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31) The influence on property values brought about by a net benefit related to the value of public goods less their cost is referred to as:

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A) a capital gain. B) a capital loss. C) the capitalization effect. D) the depreciation effect.

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32) When a homeowner improves some aspect of his property far in excess of comparable properties in the neighborhood, he is said to have: A) underimproved the property. B) overimproved the property. C) reached the point of increasing returns. D) exceeded the breakeven point.

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33)

Federal income tax policy has generally been thought to: A) discourage homeownership. B) encourage renting. C) increase interest rates. D) encourage homeownership.

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34)

Which of the following is NOT tax deductible for homeowners? A) Points in mortgage loans B) Mortgage interest C) Property taxes D) Maintenance expenses

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35) A home sales transaction in which the seller was not under undue pressure to sell for a discounted or inflated price (e.g., foreclosure, selling to family member, etc.) is referred to as a(n): A) aboveboard transaction. B) arm’s-length transaction. C) parsed transaction. D) tainted transaction.

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36)

Which of the following is NOT a factor in causing a property to become distressed? A) Borrower’s personal debts B) Delinquent property taxes C) Delinquent homeowner’s insurance bill D) Borrower’s inability to make mortgage payments

Question Details Topic : Investing in "Distressed Properties" Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

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Answer Key Test name: Ch07 1) TRUE An increase in the cost of rental housing lowers the relative cost of purchasing, so demand for purchasing increases. 2) FALSE An increase in the mortgage rates increases the cost of purchasing which lowers the demand for purchasing. 3) TRUE These are point-in-time measures but not future forecasting measures. 4) FALSE Financing benefits impact the selling price of the given property but does not lower the price of comparable properties to which the benefits were not applied at time of sale. 5) FALSE Housing bubbles occur when there are increases in the price of homes. 6) FALSE The sales price is used in the sales comparison approach. Costs are not included. 7) TRUE Tax deductible expenses include mortgage interest and property taxes. 8) TRUE

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The capitalization effect relates to the quality of the public services that individuals receive relative to the taxes (usually property tax and fees) that are paid for these services when they choose to purchase housing in a particular neighborhood or municipality. 9) TRUE Increased populations mean that additional housing is needed, which results in increasing house prices. 10) TRUE The quality of the school district is a major factor that impacts the prices of homes in the district. 11) FALSE The sales comparison approach is a common approach used to appraise the value of property. 12) TRUE Current market data is needed to determine the value of the land to be used in the cost approach. 13) FALSE Appraiser’s judgement based on experience and knowledge of the market is required. For example, judgement is needed to determine the appropriate comparable properties to use in the sales comparison approach. 14) FALSE There are several common approaches that are used in practice including the cost and income approaches. 15) TRUE Futures contracts do not involve transferring the deed, so no ownership transfer occurs for investors. Version 1

16) FALSE Employment multipliers are elements of economic base analysis used to determine how total employment in a region is affected by changes in base employment. 17) FALSE Comparables should be in the same submarket or in close proximity to the subject property. Comparables are chosen from those properties that have sold most recently and where adjustments for dissimilarities (such as the size of dwelling, lot, amenities) can be kept at a minimum. 18) TRUE All of these elements should be considered by potential investors when determining whether it is profitable to invest in a distressed property. 19) D = (1.04-1)/[1*(1-0.9)] = 0.40, or 40%. 20) B The so-called “wealth effect.” This is the effect that expected appreciation in assets, including home equity, may have on consumer spending on other goods and services in the economy. 21) B =RATE(5,0,-40000,80000) = 14.9% 22) B The location quotient is equal to the region’s share of employment in a given industry divided by the U.S.’s share of employment in a given industry. 23) C

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The capitalization effect relates to the quality of the public services that individuals receive relative to the taxes (usually property tax and fees) that are paid for these services when they choose to purchase hous¬ing in a particular neighborhood or municipality. 24) B The objective of the appraisal is to establish a market value, usually meaning the most probable price that would be paid for a property under competitive market condi-tions. 25) B The market, cost, and income approaches are the common methods used to determine valuation. Ratio analysis is not used to establish value in an appraisal. 26) B To ensure that dissimilarities are adjusted for, the value of the third bedroom should be deducted from the price of the comparable property in order to appropriately compare it to the subject property. 27) C There is an element of subjectivity in the appraisal process, so the appraised value is the actual opinion of the appraiser, but does not necessarily reflect the actual value, selling price, or replacement value of the property. 28) B Mortgage interest is tax deductible. Mortgage principal and insurance premiums are not tax deductible for primary residences. 29) C The capital gain is the net of the selling price and the acquisition cost. 30) C Version 1

Factors that increase the demand for housing include increased employment opportunities in the market, increased population size, and increased household incomes. Higher interest rates result in higher mortgage costs and higher opportunity costs to borrowing, both of which decrease the demand for housing. 31) C The capitalization effect relates to the quality of the public services that individuals receive relative to the taxes (usually property tax and fees) that are paid for these services when they choose to purchase hous-ing in a particular neighborhood or municipality. 32) B When the addition to market value is not equal to or higher than the cost of the improvement because the buyers composing the market for the property are not willing to pay as much for such an improve-ment as the current owner, then the owner is said to have overimproved the property, and its full cost may not be reflected in the sale price. 33) D Federal income tax policy generally encourages home ownership through offering tax incentives, including mortgage interest tax deductions. 34) D Property taxes, mortgage interest, and property taxes are currently tax deductible expenses. Maintenance expense is not tax deductible on primary residences. 35) B Arm’s-length transactions are those that would have occurred in the fair market, so they are free from undue pressures that may have resulted in differences to the sales price versus the fair market value price. Version 1

36) C Some of the personal financial and/or legal situations affecting the owner that may explain why properties become distressed are: borrower inability to make mortgage payments, market value of the property below the mortgage balance, delinquent property taxes/property tax liens, IRS tax liens, civil judgments/bankruptcy/divorce, mechanics and/or construction loan liens, personal debts, estate settlements.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) For a loan with an LTV greater than 80 percent, the costs of mortgage insurance always exceed the costs of second lien financing. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

2) The Federal Housing Administration provides mortgage insurance, but does not make loans. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

3) General industry standards for a conventional loan specify a maximum LTV of 60 percent. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

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4) Determining the APR for federal truth-in-lending purposes is more complicated for an adjustable rate mortgage loan than it is for a fixed rate mortgage loan. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

5) The APR for an adjustable rate mortgage loan is an accurate measure of the actual cost of funds to the borrower. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

6) A residential real estate closing involves two actual closings: the loan closing and the sales transaction closing. ⊚ true ⊚ false Question Details Difficulty : 2 Medium Topic : Closing Process Accessibility : Keyboard Navigation Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible Gradable : automatic

Financing costs are usually paid by the lender to either the borrower/buyer or the seller.

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⊚ ⊚

true false

Question Details Difficulty : 2 Medium Topic : Closing Process Accessibility : Keyboard Navigation Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible Gradable : automatic

Proration involves a professional who rates the quality of the property. ⊚ true ⊚ false

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9) To protect themselves from loss due to default, most lenders require borrowers to acquire hazard insurance policies. ⊚ true ⊚ false Question Details Topic : Mortgage Classifications Difficulty : 2 Medium Accessibility : Keyboard Navigation Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible Gradable : automatic

10)

Title insurance protects the buyer from title claims against the property. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

11) One of the objectives of RESPA was to disclose kickbacks and unearned fees on the settlement sheet. ⊚ true ⊚ false Question Details Difficulty : 2 Medium Topic : Closing Process Accessibility : Keyboard Navigation Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible Gradable : automatic

12) RESPA requires a lender to disclose good faith estimates of closing costs within three days of loan application. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Closing Process Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

13)

The FTL Act and RESPA essentially say the same things. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : Closing Process Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

14) The FTL Act requires that the lender provide a financing statement of the exact closing costs within three days of loan application. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Closing Process Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

15)

The calculated APR usually represents the true costs of financing. ⊚ true ⊚ false

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16) A conforming mortgage is one for which the US Treasury will provide credit backing through the GSEs. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : Mortgage Classifications Accessibility : Keyboard Navigation Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible Gradable : automatic

17)

Someone with a credit score of 900 is likely to only qualify for a subprime loan. ⊚ true ⊚ false

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18) A borrower who was required to purchase private mortgage insurance as a condition of their mortgage should be able to eliminate that requirement if the LTV of a home is proven to have dropped to less than 85 percent. ⊚ true ⊚ false Question Details Difficulty : 2 Medium Topic : Underwriting Process Accessibility : Keyboard Navigation Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible Gradable : automatic

19) In order to avoid the requirement to purchase private mortgage insurance when the LTV is greater than 80 percent, a buyer may be able to take out a first mortgage for 80 percent or less and couple it with a second mortgage to account for the remainder of the necessary funds. ⊚ true ⊚ false

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 20) In some cases, lenders require that borrowers obtain default insurance. The purpose of such insurance is to: A) decrease the effective interest rate on the loan. B) increase the value of the underlying property. C) protect the borrower from defaulting on the loan. D) protect the lender from losses associated with borrower default on the loan.

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21) Which of the following is NOT typically included in housing costs used to calculate a borrower’s payment-to-income ratio? A) Principal and interest on the mortgage applied for B) Mortgage insurance C) Property taxes D) Utilities

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22)

A conforming loan: A) exceeds the loan limits of loans that Fannie Mae and Freddie Mac can buy. B) meets loan limits of loans that Fannie Mae and Freddie Mac can buy. C) cannot be purchased by GSEs such as Fannie Mae and Freddie Mac. D) is another term for a fixed rate mortgage loan.

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23)

A jumbo loan: A) is another term for an adjustable rate mortgage loan. B) meets loan limits of loans that Fannie Mae and Freddie Mac can buy. C) tends to have a higher interest rate than conforming loans. D) has lower LTV requirements than conforming loans.

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24)

The payment-to-income ratio is BEST described as the: A) factor used to determine if interest on mortgage loans is tax deductible. B) only measure of a borrower's ability to fulfill his or her loan obligations. C) ratio of the estimated rental income to the expected payments on a rental property. D) ratio of the expected payments on a property to the income of the borrower.

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25)

An escrow account:

A) ensures that a default insurance policy does not lapse if a borrower is in danger of default. B) ensures that sufficient funds are collected to make annual hazard insurance and property tax payments. C) is a non-interest-bearing account into which a borrower prepays certain fees and taxes. D) is characterized by all of the choices.

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26)

Which of the following groups customarily does NOT attend a real estate closing?

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A) The buyer and seller B) The buyer’s and seller’s immediate families C) Real estate broker(s) D) Settlement agent(s)

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27) What document usually summarizes the sources, disbursements, charges and credits associated with a real estate closing? A) The purchase contract B) The deed of trust C) The listing agreement D) The settlement statement

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28) Which of the following is typically NOT one of the financing costs associated with the financing of real estate? A) Mortgage insurance fees B) Loan application and credit report fees C) Appraisal fees D) Loan discount and prepaid interest fees

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29) Which of the following is typically NOT one of the settlement costs that are escrowed over the life of the loan? A) Property taxes B) Mortgage insurance C) Selling commissions D) Hazard insurance

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30)

Which of the following is NOT one of the essential aspects of RESPA? A) Advance disclosure of settlement costs B) Limitations on the cost of mortgages C) Prohibition of kickbacks and unearned fees D) Limitations on escrow deposits

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31) RESPA requires lenders to disclose to buyers a good faith estimate of certain closing costs within: A) one day before the real estate closing. B) three days before the real estate closing. C) one day after loan application. D) three days after loan application.

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32) The uniform settlement statement presented at the closing displays settlement summaries for which of the following parties? A) Borrower and seller B) Borrower and broker C) Borrower, seller, and broker D) Borrower, seller, and lender

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33)

Which of the following is the main objective of the FTL legislation?

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A) More effective advance disclosure of settlement costs B) More informative disclosure of the cost of credit C) Elimination of kickbacks and unearned fees D) A reduction in the amount of escrow placed in accounts for homeowners

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34) RESPA requires lenders to disclose to buyers a uniform settlement statement detailing all closing costs within: A) one day before the real estate closing. B) three days before the real estate closing. C) one day after loan application. D) three days after loan application.

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35)

The APR estimate must be accurate to the nearest __________ percent. A) 1/2 B) 1/4 C) 1/8 D) 1/16

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36) A self-employed borrower who has documentable assets but is not able to provide adequate documentation for his income may be eligible for which type of loan? A) FNMA B) FHLMC C) Conforming D) Alt-A

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37)

GSE is the abbreviation for: A) government-sponsored entity. B) government-specific entity. C) government-sponsored enterprise. D) government-specific enterprise.

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38) Which of the following organizations provides lenders with complete protection against default losses? A) FHA B) FNMA C) FHLMC D) VA

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Answer Key Test name: Ch08 1) FALSE The costs of mortgage insurance should be compared to the costs of second lien financing to determine which cost is lower. 2) TRUE The FHA does not act as a lender but does provide mortgage insurance. 3) FALSE The general industry standards specify an 80 percent LTV. 4) TRUE The varying rates that may be applied in an adjustable rate mortgage make the APR calculation more complex than the calculation for a fixed rate APR. 5) FALSE The method of computing the APR on an ARM will almost certainly not reflect the true cost of funds to the borrower. Clearly, a decrease or increase in the index over the loan term would cause the stated APR to be incorrect. 6) TRUE Both the loan and sales transaction closings are components of the residential real estate closing process. 7) FALSE These charges are generally paid by the buyer/borrower to the lender and are made in connection with services performed by the lender when underwriting and approving the loan. Version 1

8) FALSE Proration involves adjusting an amount based on remaining days elapsed and still remaining. For example, if a monthly property tax is $100, but the sale of the property occurs exactly halfway through the month, then the amount of taxes owed by the new owner would be prorated to include a charge for only the half of the month in which the new owner holds title to the property. 9) FALSE Hazard insurance is required by the lender to protect themselves against loss due to property damage. 10) TRUE Title insurance is recommended as it protects the buyer from outstanding claims against the title for the property. 11) FALSE RESPA is a law passed by Congress to provide a uniform set of procedures and docu-ments for buyer/borrowers of residential real estate. 12) TRUE Good faith estimates of the closing costs must be disclosed within three days of the loan application under the RESPA requirements. 13) TRUE RESPA and FTL are very similar. RESPA is a law passed by Congress to provide a uniform set of procedures and docu-ments for buyer/borrowers of residential real estate. The intent of FTL legislation is to require that lenders disclose to borrowers financial information contained in loan agreements in a uniform manner. 14) FALSE

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The closing costs should be accurate according to the FTL guidelines. However, they may not be exact, as changes may still be warranted between the disclosure and the closing date. 15) FALSE The method of computing the APR may not reflect the true cost of funds to the borrower. For example, with an ARM, a decrease or increase in the index over the loan term would cause the stated APR to be incorrect. 16) TRUE The conforming mortgage category specifies the loan amount that Congress has autho-rized as the maximum mortgage loan that these GSEs may purchase from lenders and for which the U.S. Treasury will provide credit backing. 17) FALSE The credit score of 900 is considered very good and would result in likely approval for a standard loan. 18) FALSE The requirement may be dropped if the LTV drops below 80 percent. 19) TRUE PMI is usually required for loans that are over 80 percent of value. However, borrowers who need loans in excess of 80 percent of value may consider a first lien for 80 percent, and then add a second lien for the addi-tional amount needed. By keeping the first lien at or below 80 percent, borrowers may avoid PMI. 20) D Default insurance protects the lender from borrower default. 21) D

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A borrower’s payment-to-income ratio typically includes the principal and interest on the potential mortgage, property tax expenses, and mortgage insurance premiums. Utilities are not included. 22) B FNMA and FHLMC dominate the conforming loan market because of their GSE status, which includes possible market support at the option of the U.S. Treasury. 23) C Because jumbo loans are made in larger amounts and are not backed with government guarantees, FNMA and FHLMC must compete for them with non-GSE lenders. Because of this competition, jumbo loans are usually made by many lenders at higher inter-est rates than those of conforming loans. 24) D The payment-to-income ratio is the monthly payment on the loan amount being applied for plus other housing expenses divided by the borrower’s income. 25) D An escrow account is a non-interest-bearing account into which are deposited prorated taxes from the seller and into which the borrower prepays a monthly share of property tax along with the monthly mortgage payment. 26) B Generally, such closings are attended by (1) the buyer and seller (perhaps each with legal counsel), (2) any real estate brokers involved, and (3) the settlement agent. 27) D

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To summarize the disbursements, charges, and credits associated with the closing, a settlement of closing statement is prepared by the settlement agent. This statement summarizes the expenses and fees to be paid by the buyer and seller, and it shows the amount of funds that the buyer must pay and the amount of funds that the seller will receive at closing. 28) A Financing charges are generally paid by the buyer/borrower to the lender and are made in connection with services performed by the lender when underwriting and approving the loan. Mortgage insurance fees are not considered a financing cost. 29) C Selling commissions are paid at closing and are not included in escrow accounts. 30) B RESPA is a law passed by Congress to provide a uniform set of procedures and docu-ments for buyer/borrowers of residential real estate. Mortgage costs are not limited by RESPA. 31) D Under RESPA, the good faith estimate of closing costs is required to be disclosed by the lender to the buyer within three days of the loan application. 32) A Under RESPA provisions, a uniform settlement statement must be used by the settlement agent at closing. The responsibility for preparation of this statement lies with the lender, and it must be delivered to the borrower and seller at closing.

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33) B The intent of FTL legislation is to require that lenders disclose to borrowers financial information contained in loan agreements in a uniform manner. This is required so that borrowers can compare the cost of different loan agreements. 34) A Not only must a uniform settlement statement be used at the closing, but the borrower has the right to inspect this statement one day prior to closing. 35) C The APR as calculated by the lender may be rounded up or down to the nearest one-quarter of a percent. However, after rounding, it must fall within the nearest one-eighth of a percent of the APR calculated based on FTL calculation requirements. 36) D The term ALT-A stands for “alternative to A paper,” where “A paper” is a low risk, conforming loan. When ALT-A loans are underwritten, some aspect of the loan application cannot be verified, such as selfemployment income. However, the borrower may have sufficient assets (cash, stocks, etc.) to be approved for a loan. ALT-A loans also are sometimes referred to as “low doc” (low documentation) loans. 37) C Government-sponsored enterprises, or GSEs, are a key part of the secondary residential mortgage market in the U.S. 38) A

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A mortgage loan can also be insured by the Federal Housing Administration (FHA). Unlike conventional insurance, which protects the lender against some portion of the potential loan loss, FHA mortgage insurance insures the lender completely against any default losses.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Analysis of effective rents tends to be superior to analysis of total rents over the life of a lease. ⊚ true ⊚ false Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Topic : General Contents of Leases Gradable : automatic

2) The existing stock of space cannot be adjusted in the short run, but can be increased or decreased in the long run. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Supply and Demand Analysis Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

3) To attract anchor tenants, property owners tend to charge them lower rents. They make up for the lower rents by charging the anchor tenant higher CAM charges. ⊚ true ⊚ false Question Details Topic : Property Types Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

Overage rent is rent that exceeds expenses.

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⊚ ⊚

true false

Question Details Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Topic : General Contents of Leases Gradable : automatic

The term "percentage rent" refers to rent paid as a percent of space leased. ⊚ true ⊚ false

6) A gross lease is one in which the tenant only pays rent, and the owner of the property pays the operating expenses and provides all services. ⊚ true ⊚ false Question Details Topic : Leases Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

7) The term "usable area" is typically synonymous with "leasable area," in a building with multiple tenants. ⊚ ⊚

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true false

Question Details Topic : Leases Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

The use of a CPI index in a lease contract shifts risk to the tenant. ⊚ true ⊚ false

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Expense stops protect the lessee from unexpected changes in market rents. ⊚ ⊚

true false

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10)

A gross lease is riskier for the lessor than a net lease. ⊚ true ⊚ false

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11) In projecting cash flows for an office property, net operating income is the income after deduction of mortgage payments. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Operating Cash Flows Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

12)

Free rent is a concession that a building owner may offer. ⊚ true ⊚ false

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13)

CPI adjustments are used to adjust rents by all or part of the increase in the CPI. ⊚ true ⊚ false

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Question Details Topic : Leases Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

14)

Condominium complexes are considered to be nonresidential properties. ⊚ true ⊚ false

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15) The great majority of businesses lease the space they occupy rather than purchasing it outright. ⊚ true ⊚ false Question Details Topic : Leases Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question.

16) Consider the figure above. Point D represents: A) equilibrium occupancy. B) market rent. C) vacancy. D) shortage.

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17) Consider the figure above. The difference between the existing stock of space and Point D represents: A) equilibrium occupancy. B) market rent. C) vacancy. D) shortage.

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18) Consider the figure above. If the demand for units increases, what would happen in equilibrium, holding everything else constant? A) Market rent would decrease; equilibrium occupancy would decrease B) Market rent would decrease; equilibrium occupancy would increase C) Market rent would increase; equilibrium occupancy would decrease D) Market rent would increase; equilibrium occupancy would increase

Question Details Difficulty : 3 Hard Topic : Supply and Demand Analysis Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

19) For which of the following reasons would a business prefer to own space rather than lease it?

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A) The business demands specialized or unique facilities. B) Owning allows the business to develop skills in operating, maintaining, and repairing real estate and the associated facilities. C) Owning reduces operating flexibility. D) The capital commitments with owning are lower than the capital commitments associated with leasing.

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20) A building owner charges net rent of $20 in the first year, $21 in the second year, and $22 in the third year. Using a 10 percent discount rate, what is the effective rent over the three years? A) $20.00 B) $20.94 C) $21.73 D) $52.07

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21) A building owner charges net rent of $20 in the first year, $21 in the second year, and $22 in the third year, but is providing six months of free rent in the first year as a concession. Using a 10 percent discount rate, what is the effective rent over the three years?

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A) $17.28 B) $18.94 C) $20.94 D) $42.98

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22)

Which of the following is NOT considered to be an office or retail property? A) Single tenant—build to suit B) Regional shopping center C) Warehouse D) Community center

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23) The difference between the existing stock of space and the equilibrium occupancy is known as: A) supply. B) demand. C) equilibrium. D) vacancy.

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24) The dollar amount by which total rent exceeds base rent under a percentage lease for retail is referred to as: A) overage rent. B) excess rent. C) percentage rent. D) marginal rent.

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25)

The supply of space is: A) inelastic in both the short run and the long run. B) elastic in both the short run and the long run. C) relatively inelastic in the short run, and highly elastic in the long run. D) relatively elastic in the short run, and highly inelastic in the long run.

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26) Expenses for a 1,000-square-foot office space are $6.00 per square foot. The lease specifies an expense stop of $5.40. What is the total expense paid by the landlord? A) $5,400 B) $6,000 C) $600 D) $0

Question Details Topic : Expense Stops Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

27) A 1,500-square-foot office space is leased at $12.00 square foot. The space is vacant one month out of the year. Office expenses are $6.50 per square foot and an expense stop is set at $6.00 per square foot. What is the annual net operating income? (Assume no additional expenses during the month of vacancy) A) $7,500 B) $6,750 C) $15,750 D) $8,250

Question Details Difficulty : 3 Hard Topic : Expense Stops Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

28) A clause which requires a tenant in retail space to achieve a certain level of sales or the lease will be terminated is referred to as a(n): Version 1

A) change clause. B) termination clause. C) option clause. D) santa clause.

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29) A clause in a non-anchor tenant's lease requiring the presence of an anchor tenant is referred to as a(n): A) Noncompete clause. B) Cotenancy clause. C) Joint tenancy clause. D) Anchor clause.

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30) Income after deducting loss of rents due to vacancy and nonpayment of rents, as well as any concessions, is referred to as: A) potential gross income. B) effective gross income. C) net operating income. D) before-tax cash flow.

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31) A 1,000-square-foot office space is leased at $15.00 per square foot during the first year with $2.00 step-up provisions each of the following years. The lease is gross with an expense stop set at $6.65 per square foot, and yearly expenses per square foot are as follows: $6.00, $6.65, and $7.05. The lease provides for two months of free rent at the end of the lease term. If the lease term is three years and the discount rate is 10 percent, what is the effective rent per square foot? A) $9.38 B) $9.50 C) $10.22 D) $10.46

Question Details Difficulty : 3 Hard Topic : Effective Rents Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Gradable : automatic

32)

Which of the following does the term "anchor tenant" usually refer to? A) Someone who leases space B) The largest tenant in an office building C) A department store in a mall D) The tenant who pays the highest rent in a mall

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33)

Which of the following describes the function of an expense stop in a lease? A) Expenses are stopped from increasing B) Expenses above the stop are paid by the owner C) Expenses above the stop are paid by the tenant D) Expenses below the stop are paid for by the tenant

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34)

Which of the following is TRUE for a net lease? A) All expenses are paid by the owner B) All expenses are paid by the tenant C) All expenses are paid by the lender D) All expenses are paid by the investor

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35)

Which of the following tends to lower effective rents? A) Percentage rent B) Step-up provisions C) Concessions D) CPI adjustment

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36)

Which of the following does the term "in-line tenants" refer to? A) Smaller stores in a mall that are not anchor tenants B) Tenants whose sales are in line with estimates C) Tenants who pay their rents on a timely basis D) All stores located inside the mall, including anchors

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37)

In general, what inputs determine lease revenue?

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A) Base rent per square foot × quantity leased to tenants B) Base rent per square foot × quantity owned by landlord C) Discounted rent per square foot × quantity leased to tenants D) Discounted rent per square foot × quantity owned by landlord

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38)

Which of the following leads to rent premiums? A) Apartments on the periphery of a site; higher floors with no elevators B) Second or third levels in multi-level malls C) Middle floors in an office building D) Apartments on higher floors with elevators

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39) The price a potential tenant must pay to lease a specific type of real estate under the current economic conditions is: A) percentage rent. B) market rent. C) effective rent. D) base rent.

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Question Details Topic : Leases Difficulty : 1 Easy Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Gradable : automatic

40)

Which of the following would be considered as expense pass throughs in a lease? A) Electricity B) Landscaping fees C) Security costs D) Property taxes

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41) A manufacturing business is contracting to lease a large, open building and is seeking to add partition walls and a large air conditioning unit in order to accommodate its specific needs. What type of lease is the building owner likely to want to agree to? A) Gross lease B) Modified lease with direct pass throughs C) Single net lease D) Triple net lease

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Question Details Topic : Leases Difficulty : 2 Medium Accessibility : Keyboard Navigation Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Gradable : automatic

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Answer Key Test name: Ch09 1) TRUE Because of the large number of possible combinations of lease terms, cash flows may vary considerably from lease to lease, making it difficult to establish the true lease cost. This also makes comparisons between leases difficult. Therefore, it is useful to calculate a single measure or effective rent that can be used for comparison of individual leasing alternatives. 2) TRUE In the short run, the existing stock of space is fixed but space is variable in the long run. 3) FALSE In many situations, anchor tenants may pay less per square foot for CAM expenses than in-line tenants may pay. 4) FALSE The dollar amount by which the total rent exceeds the base rent is referred to as overage rent. 5) FALSE In some retail leases, rents also may be fully or partially determined by an indicator of retail sales performance. For example, some leases in shopping centers may include a provision for rents to be par-tially based on the tenant’s sales volume. This is referred to as a percentage rent lease. 6) TRUE

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With a gross lease, the tenant pays the rent charge and the lessor (owner) will be responsible for the payment of all operating expenses. 7) FALSE When multiple tenants share a space, the difference between the total leasable area (or space that would be used if only one tenant occupied that floor) and usable area occupied by multiple tenants is a common area. 8) TRUE Linking rents or charges to a CPI index helps shift risk of inflation and pricing changes from the owner to the tenant. 9) FALSE Expense stops create a cap on expenses and protect the lessee. 10) TRUE Net leases are less risky for the lessor because total operating expenses pass through to the tenant. 11) FALSE From effective gross income, operating expenses and the CAPEX allowance are deducted, and the net result is the net cash flow, also referred to as net operating income (NOI). 12) TRUE Free rent for a period of time is an example of a concession that may be offered by a building owner to attract tenants. 13) TRUE CPI adjustments help shift risk from the lessor to the lessee by adjusting rents to changes in the CPI. 14) FALSE

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Condominiums are an example of residential properties. In general, residential properties are properties that provide residences for individuals or families. 15) TRUE Contrary to popular belief, the vast majority of real estate used by business firms is leased and not owned. 16) A Point D is the intersection of the supply and demand curves, so this represents equilibrium occupancy.

17) C Point D is the intersection of the supply and demand curves, so this represents equilibrium occupancy. The difference between this point and the existing stock of space is excess space, or vacancy.

18) D The demand for units would cause the demand curve to shift up and to the right, which would result in an increase in the market rent and the equilibrium occupancy point (i.e., the intersection of the new demand curve and the existing supply curve).

19) A When a business requires a unique or specialized facility, it is often advantageous to acquire the building in order to purchase the ability to have flexibility in changing the facility as needed. 20) B Step 1: Calculate the present value of the rent charges: $20/1.101 + $21/1.102 + $22/1.103 = $52.07. Step 2: Calculate the annualized equivalent of the present value: =PMT(0.1,3,-52.07) = $20.94. 21) A Step 1: Calculate the present value of the rent charges: $10/1.101 + $21/1.102 + $22/1.103 = $42.98. Step 2: Calculate the annualized equivalent of the present value: =PMT(0.1,3,-42.98) = $17.28. Version 1

22) C Single tenant—build to suit is classified as office property. Regional shopping centers and community centers are classified as retail property. Industrial and warehouse buildings are considered to be a separate property classification. 23) D Vacancy represents the excess of existing stock space over the equilibrium occupancy level. 24) A The dollar amount by which the total rent exceeds the base rent is referred to as overage rent. 25) C In the short run, the existing stock of space is fixed (inelastic) but space is variable (elastic) in the long run. 26) A The total expense paid by the landlord is 1,000 square feet multiplied by the $5.40 per square foot expense stop, which equals $5,400. 27) A

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Step 1: Calculate the total revenue assuming one month of vacancy per year: ($12 per square foot × 1,500 square feet)/12 months per year × 11 months occupied = $16,500. Step 2: Calculate the annual expense assuming the expense stop: $6.00 per square foot × 1,500 square feet = $9,000. Step 3: Subtract expenses from net revenue: $16,500 − $9,000 = $7,500. 28) B A termination clause specifies that the tenant must achieve a certain level of sales per square foot within a specific period of time (e.g., two years), otherwise either the property owner or the tenant may terminate the lease. 29) B The cotenancy clause is a demand commonly made by tenants who require the continued presence of a certain anchor or other tenants as a condition of mak-ing a lease with the property owner. 30) B After other sources of income and expense recoveries are determined, cash inflow is then reduced by loss of rents because of vacancies and nonpayment of rents (because of ten-ant bankruptcy, etc.). After these allowances are deducted, the resultant effective gross income is the amount of cash flow available to the owner to pay operating expenses. 31) B

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Step 1: Calculate the rents for each year: Year 1 = $15; Year 2 = $15 + $2 step-up = $17; Year 3 = $17 + $2 stepup = $19/12 months x 10 months of payment to exclude the two months of free rent = $15.83. Step 2: Calculate the expense paid by the tenant each year, which is the yearly expense or the expense stop of $6.65, whichever is lower: Year 1 = $6.00; Year 2 = $6.65; Year 3 = $6.65. Step 3: Calculate the net of the rent and the expense for each year: Year 1 = $15.00 − $6.00 = $9.00; Year 2 = $17.00 − $6.65 = $10.35; Year 3 = $15.83 - $6.65 = $9.18. Step 4: Calculate the present value of the net amounts from Step 3: $9.00/1.101 + $10.35/1.102 + $9.18/1.103 = $23.64. Step 5: Calculate the effective rent per square foot: = PMT(0.1,3,−23.64) = $9.50. 32) C Anchor tenants are tenants who lease very large amounts of space. These are typically department stores in a mall. 33) C In order to establish a base line of recoverable expenses at the time the tenant takes occupancy, the lease will generally specify that tenants will pay only a share of increases in recoverable expenses in excess of what is referred to as an expense stop. 34) B In a net lease, the total operating expense pass through to tenants. 35) C

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Property owners may have provided tenants with concessions, such as move-in allowances or rent reductions for a specified period of time. These are inducements for new tenants to lease space or to keep old tenants who are renewing leases. 36) A In-line tenants tend to be smaller retailers that hope to generate retail sales as a result of participating in the high shopping traffic, part of which is produced by the anchor tenants. 37) A Base rent per square foot multiplied by the quantity leased to tenants determines revenue. 38) D Higher floors apartments in buildings with operating elevators tend to result in higher rents, as tenants appreciate better views. 39) B Market rent is the cost of rent assuming the current market conditions. 40) D Examples of such expense pass throughs are property taxes and insurance. 41) D Triple net leases are commonly used by tenants occupying large amounts of space in warehouse/industrial properties or office buildings. In these cases, tenants may require the flexibility to modify, move fixtures, and reconfigure the interior space in order to operate their business efficiently. However, tenants usu-ally must be willing to pay for the cost of doing so.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The sales comparison approach to appraisal is preferred because it is the only objective appraisal approach. ⊚ true ⊚ false Question Details Topic : Sales Comparison Approach Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

2) When using the gross income multiplier technique in conjunction with the income approach to valuation, potential gross income is preferred to effective gross income. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : GIM Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

3) One advantage of the gross income multiplier technique is that it is most suitable for properties in which operating expenses vary widely across the properties being surveyed. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : GIM Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

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4) The rationale for using the cost approach to appraisal is that any informed buyer would not pay more for a property than what it would cost to buy the land and build the structure. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Cost Approach Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

5) When conducting an appraisal, only one of three approaches should be selected to determine the property value. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Appraisals Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

6) In the cost approach to valuation, land value can be estimated by comparing sales of vacant land that are similar to the subject land. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Cost Approach Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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7) In the income approach to valuation, replacement cost is reduced by costs such as those that are associated with curing deterioration of the property and the economic loss of value from incurable factors due to change in design or layout efficiency. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Cost Approach Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

8) A building has 12 foot ceilings that cause the electric bill to be $1,200 higher per year than a conventional ceiling height. Depreciation caused by the ceilings can be estimated by calculating the present value of the $1,200 per year over the remaining economic life of the building. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Cost Approach Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

9) A gross income multiplier can be calculated by dividing the gross income by the sales price. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : GIM Difficulty : 1 Easy Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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10) An overall capitalization rate can be calculated by dividing the net operating income by the property value. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Capitalization Rate Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

11) The capitalization rate is equal to the discount rate minus any expected annual growth in income and property value. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Capitalization Rate Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

12) A property is purchased for $350,000. Based on an annual growth rate of 3 percent, the resale value at the end of Year 10 would be $456,671. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Reversion Value Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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13) The capitalization rate for a leased fee estate should always be lower than the capitalization rate for a fee simple estate. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Capitalization Rate Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

14) The equity value can be estimated by subtracting debt service from net operating income and dividing this amount by the equity dividend rate. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Equity Capitalization Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

15) The cost approach is not reliable when the structure is relatively new and depreciation does not present serious complications. ⊚ true ⊚ false Question Details Topic : Sales Comparison Approach Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

16)

Appraisers use bracketing in order to estimate the upper and lower range of value.

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⊚ ⊚

true false

Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Appraisals Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

17) Return on investment and change in net operating income are essential factors for cost analysis. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Cost Approach Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

18) The capitalization rate of a newly constructed apartment building will be more than that of a relatively old apartment building, which is comparable in all other aspects. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Capitalization Rate Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

19) The assumption that a knowledgeable buyer would not pay more for property than what other buyers have recently paid for comparable properties provides the rationale for the sales comparison approach.

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⊚ ⊚

true false

Question Details Topic : Sales Comparison Approach Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

20) The discount rate establishes the minimum return that an investor is willing to accept when evaluating the potential purchase of an income-producing property. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Income Approach Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 21) Consider the table. Assume that the subject property has effective gross income of $53,000 and an NOI of $27,500. What value would a GIM approach yield (rounded to the nearest $100)? Comp 1

Comp 2

Comp 3

Price Effective gross income % operating expense

$ 300,000 50,000 50%

$ 350,000 55,000 55%

$375,000 60,000 54%

NOI

$ 25,000

$ 30,000

$ 32,500

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A) $322,600 B) $325,600 C) $328,800 D) $330,000

Question Details Difficulty : 3 Hard Accessibility : Keyboard Navigation Gradable : automatic Topic : GIM Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply

22) Consider the table. Assume that the subject property has effective gross income of $53,000 and a NOI of $27,500. What value would a cap rate approach yield (rounded to the nearest $100)? (Do not round the average NOI as % of price intermediate calculation.) Comp 1

Comp 2

Comp 3

Price Effective gross income % operating expense

$ 300,000 50,000 50%

$ 350,000 55,000 55%

$375,000 60,000 54%

NOI

$ 25,000

$ 30,000

$ 32,500

A) $322,600 B) $325,600 C) $328,600 D) $330,000

Question Details Difficulty : 3 Hard Accessibility : Keyboard Navigation Gradable : automatic Topic : Capitalization Rate Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply

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23) Which of the following statements regarding the sales comparison approach to appraisal is TRUE? A) As a "rule of thumb" transactions involving foreclosures should be discounted by 10 percent. B) The comparable buildings’ characteristics are more important than the comparable properties’ locations for performing the sales comparison. C) The comparable sales must involve transactions between unrelated individuals. D) The only factors important for comparable analysis are property size, building size, age of the building, and the condition of building.

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24) Which of the following techniques is NOT associated with the income approach to valuation? A) Capitalization rate B) Discounted present value C) Factor discounting rates D) Gross income multiplier

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25) Consider a building with a very long economic life. Assume at the end of Year 6, NOI will be $80,000 and is expected to grow at a rate of 2 percent per year. Your company’s required rate of return is 12 percent. As part of your analysis, you must calculate the reversion value (REV) at the end of Year 5, which would be: A) $571,429. B) $666,667. C) $800,000. D) $4,000,000.

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26) Consider a property with NOI of $72,000 and a debt coverage ratio of 1.2 applied to first year NOI. What would be the estimated monthly mortgage payment? A) $5,000 B) $7,200 C) $60,000 D) $86,400

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27) Consider the table for an income property that is under evaluation for purchase with a $455,000 loan. Using the principles of mortgage equity capitalization, what is the estimated total property value (rounded to the nearest $100)?

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NOI DS Cash flow Resale in Year 3

Year 1

Year 2

Year 3

$ 72,000 60,000 $ 12,000

$ 74,880 60,000 $ 14,880

$ 77,875 60,000 $ 17,875 900,000

Less mortgage balance Total cash flow Present value of cash flow @ 15%

−435,000 $ 12,000 $ 10,435

$ 14,880 $ 11,251

$ 482,875 $ 317,498

A) $317,500 B) $482,900 C) $772,500 D) $794,200

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28) Consider the table for an income property that is under evaluation for purchase with a $455,000 loan. What would be the equity dividend rate?

NOI DS Cash flow Resale in Year 3

Year 1

Year 2

Year 3

$ 72,000 60,000 $ 12,000

$ 74,880 60,000 $ 14,880

$ 77,875 60,000 $ 17,875 900,000

Less mortgage balance Total cash flow Present value of cash flow @ 15%

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−435,000 $ 12,000 $ 10,435

$ 14,880 $ 11,251

$ 482,875 $ 317,498

A) 2.4 % B) 3.5 % C) 4.2% D) 5.3%

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29)

Which of the following factors is NOT part of the definition of market value?

A) Payment is made in terms of cash in U.S. dollars or a comparable financial arrangement B) The property has been on the open market for less than a year C) Buyer and seller are typically motivated D) Price is not affected by special or creative financing

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30)

Regarding the value of a property, an appraisal: A) calculates value. B) confirms value. C) estimates value. D) determines value.

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31)

Which of the following steps normally would be used in the cost approach to value? A) Estimate net operating income of the property B) Multiply accrued depreciation by the assessed cost C) Add actual construction costs to the land value D) Subtract accrued depreciation from the replacement cost

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32)

Which of the following choices represents the main categories of depreciation? A) Physical, external, functional B) Physical, economic, locational C) External, structural, financial D) Economic, physical, external

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33) A comparable property has a feature that is superior to the subject property. What adjustment would be made in the sales comparison approach to value? A) Value of the feature would be subtracted from the sales price of the comparable property B) Value of the feature would be added to the sales price of the comparable property C) Value of the feature would be subtracted from the value of the subject property D) Value of the feature would be added to the value of the subject property

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34)

Given the following sales adjustment grid, what adjustment would be made for size?

Characteristic Sales price

Subject

1 116,000

2 120,000

3 124,000

4 126,000

Square feet Exterior Age

1,800 Alum 16

1,700 Brick 20

1,900 Alum 20

1,900 Alum 18

1,900 Brick 20

A) $23.65 psf. B) $45.82 psf. C) $65.74 psf. D) $38.26 psf.

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35) Which of the following expenses would NOT be included in an operating statement used to calculate net operating income in the income approach to value? A) Reserves for replacement B) Maintenance C) Real estate taxes D) Capital additions

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36) A property is sold for $200,000. Typical financing terms are an 85 percent loan with a 10 percent interest rate over 15 years. If the before-tax cash flow is $2,000, what is the overall capitalization rate? A) 10.96% B) 11.96% C) 19.13% D) 9.96%

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37) A property produces a first-year net operating income of $24,000. Because of the long economic life of the building, the income is considered as a perpetuity that will grow by 2.5 percent per year. Using a discount rate of 9.5 percent, the property value is estimated at: A) $276,968. B) $252,632. C) $200,000. D) $342,857.

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38) A property is leased for $24,000 per year although market rents are currently $27,500 per year and are expected to increase by 2 percent per year. The property is expected to be sold at the end of Year 10 based on a 10 percent terminal cap rate applied to the eleventh year NOI. The current lease on the property will expire at the end of Year 10 so the property can be leased in the eleventh year at market rates. What is the value of the leased fee estate based on an 11.5 percent discount rate? A) $362,489 B) $298,325 C) $251,298 D) $271,486

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39) The discount rate is a rate that a typical investor would normally require as a(n) ___ return over investment holding period. A) maximum B) risk-free C) expected D) historical

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40)

Total possible income less any vacancy is ___. A) effective gross income B) potential gross income C) net operating income D) gross income multiplier

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41)

Which of the following is TRUE concerning the capitalization rate? A) It is an IRR. B) It explicitly considers projected future income and changes in property value over

time. C) It expresses relationships between income and property value at a specific point in time. D) It is the rate of return that investors expect to earn on all capital invested.

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42) Capitalization rates will differ from yield rates when the income is expected to __________ over time. A) stay the same B) increase C) decrease D) increase, decrease, or do both

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43) Which is of the following is NOT normally considered when conducting an appraisal using the cost approach?

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A) Functional obsolescence B) Effective age C) Capitalization rate D) Replacement cost

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44)

Which lease has the LOWEST effective rent?

Lease A B C D

Year 1 10 0 0 15

Year 2 11 13 0 14

Year 3 12 14 20 13

Year 4 13 15 20 12

Year 5 14 16 22 11

A) Lease A B) Lease B C) Lease C D) Lease D

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45) Which of the following income capitalization techniques is based on the principle that buyers will not pay more for a property than the present value (PV) of all future net operating incomes (NOI)? Version 1

A) Direct capitalization method B) Effective gross income method C) Potential gross income method D) Discounted cash flow method

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46) The difference between the total property value (accounting for rents and cash flows) and the cost of constructing an improvement on a given site is the: A) residual land value. B) highest and best use value. C) land value differential. D) excess land value.

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47) The principle that an informed purchaser would not spend more for a piece of real estate than the cost to purchase the land and the cost to construct a structure provides the rationale for which of these valuation methods?

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A) Sales comparison approach B) Income approach C) Cost approach D) Direct capitalization approach

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Answer Key Test name: Ch10 1) FALSE There are several accepted appraisal approaches and each contains elements of subjectivity. 2) FALSE Either potential gross income or effective gross income may be used when using the gross income multiplier technique. 3) FALSE In cases where it is suspected that differences in operating expenses exist between comparables, the focus of the analysis should be shifted from gross income multipliers to net operating income (NOI). 4) TRUE The cost approach is based on the premise that the buyer would not want to pay more for the property than it would cost to purchase the land and build the structure. 5) FALSE In income property appraisals, at least two of three approaches are normally used: the sales comparison approach, the income capitalization approach, and/or the cost approach. 6) TRUE This is a method used in the cost approach to valuing the underlying land. 7) FALSE

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The essence of the cost approach for existing properties is first to price the improvement at its current replacement cost. 8) TRUE This is the method that should be used to calculate the depreciation under the cost approach. 9) FALSE The gross income multiplier is the sales price divided by the gross income. 10) TRUE The total capitalization rate is the net operating income divided by the property value. 11) TRUE The capitalization rate is the discount rate less the expected annual growth in property value and income. 12) FALSE $350,000 × (1 + 3%)10 = $470,371 13) FALSE The cap rate is the NOI divided by the property transaction price or value. The net rents may be higher or lower for the leased fee estate versus the fee simple estate. 14) TRUE This is the calculation for the estimated equity value. 15) FALSE The cost approach is most reliable where the structure is relatively new and depreciation does not present serious complications. 16) TRUE

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Appraisers use bracketing in order to estimate the upper and lower range of value. 17) FALSE Cost analysis involves understanding the costs of the underlying land and the cost to build the structure. ROI and net operating income include revenue elements which are not included in cost analysis. 18) FALSE After determining the NOI, it is then divided by the transaction price to obtain what is defined in the industry as the capitalization rate. Therefore, this statement may not be true, depending on the other factors of the two buildings. 19) TRUE This is the rationale behind using the sales approach for property appraisal. 20) TRUE This is the definition of the discount rate. The investor should not accept a return that is lower than the discount rate. 21) C Comp l

Comp 2

Comp 3

Price

$300,000

$350,000

$375,000

Effective gross income

$ 50,000

$ 55,000

$ 60,000

6.00

6.36

6.25

Price divided by effective gross income Average price divided by effective gross income Subject property effective gross income GIM approach subject property value (Average × Subject property

Version 1

6.20 $ 53,000 $ 328,841

effective gross income)

22) A Comp l

Comp 2

Comp 3

Price

$300,000

$350,000

$375,000

NOI

$ 25,000

$ 30,000

$ 60,000

8.3%

8.6%

8.7%

NOI as % of price Average NOI as % of Price Subject property NOI Value (Subject property NOI divided by Average NOI as % of Price)

8.5% $ 27,500 $ 322,626

23) C The comparable properties used in the sales comparison should be arm’s-length transactions to ensure that the sales prices represents the fair market price. 24) C Cap rates, discounted present value, and gross income multipliers are all components of the gross income approach to appraisals. Factor discounting is not associated with this approach. 25) C $80,000/(12% − 2%) = $800,000 26) A ($72,000/1.2)/12 = $5,000 27) D

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The estimated property value is the value of the mortgage plus the value of equity. The value of the mortgage is given as $455,000. The value of the equity is the present value of the cash flows, or $10,435 + $11,251 + $317,498 = $339,184. Adding the mortgage, results in $455,000 + $339,184 = $794,184, which rounds to $794,200. 28) B The equity dividend rate is the Year 1 total cash flow divided by the value of equity, which is the present value of all cash flows. The value of the equity is $10,435 + $11,251 + $317,498 = $339,184, so $12,000/$339,184 = .035, or 3.5%. 29) B The market value does not depend on the length of time the property has been on the open market. 30) C The purpose of an appraisal is to estimate the value of the property. This is an approximation only. 31) D Accrued depreciation should be subtracted from the replacement cost when determining value under the cost approach. 32) A Generally, when the cost approach to value is used for an existing improvement, the cost to replace the improvement is estimated and adjusted downward for depreciation caused by (1) physical deterioration, (2) functional or structural obsolescence due to the availability of more efficient layout designs and technological changes that reduce operating costs, and (3) external obsolescence that may result from changes outside of the property such as excessive traffic, noise, or pollution. 33) A

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When the comparable property has a feature that adds value but is not present in the subject property, then the value of the feature should be subtracted from the comparable property’s price to create a more appropriate comparison with the subject property. 34) C Sales price

116,000

120,000

124,000

126,000

Square feet

1,700

1,900

68.24

63.16

65.26

66.32

Average

65.74303

35) D Capital additions are not operating expenses but, rather, are considered capitalized expenses. 36) B Step 1: Calculate the monthly loan payment: $200,000 price × 85% = $170,000 loan value, so = PMT(0.1 / 12,15 × 12,−170000) = $1,826.83. Step 2: Determine the annual debt service: $1,826.83 × 12 = $21,921.94. Step 3: Calculate NOI: $21,921.94 debt service + $2,000 before-tax cash flow = $23,921.94. Step 4: Calculate the overall capitalization rate: $23,921.94 / $200,000 = 0.1196, or 11.96%. 37) D $24,000/(9.5% − 2.5%) = $342,857 38) C NOI Year 11 33,522.35 Cap rate 10% Value, Year 10 335,223 Year 1 Year 2 Year 3 Year 4 Year Year 6 Year 7 Year 8 Year 9 5 24,0 24,0 24,0 24,0 24,0 24,0 24,0 24,0 24,0 00 00 00 00 00 00 00 00 00

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Year 10 24,00 0 335,2 23

24,0 24,0 24,0 00 00 00 Discount rate NPV

24,0 00

24,0 24,0 00 00 11.50% $ 251,298.37

24,0 00

359,2 23

39) C The discount rate is the rate of return that should be expected on an investment over a given period of time. 40) A Effective gross income is defined as the possible income minus income losses due to vacancy. 41) C The capitalization rate is a point-in-time measure of the relationship between the property value and income from that property. 42) D When income changes over time, the capitalization rates will differ from the yield rates. 43) C The capitalization rate is a point-in-time measure of the relationship between the property value and income from that property. This is not a component of the cost approach to appraisal. 44) B To determine the effective rents, use the same discount rate across all leases, say 10%. Using this rate, the present value of the rents will be $44.77 for A, $41.44 for B, $42.35 for C, and $50.00 for D. Therefore, Lease B has the lowest effective rent. 45) D The discounted cash flow method, the final income capitalization technique, is based on the principle that investors will pay no more for a property than the present value of all future NOIs. 46) A Version 1

The residual land value is the difference between the total property value, which is driven by rents and cash flows, and the cost of constructing an improvement on a given site. 47) C The rationale for using the cost approach to valuing (appraising) properties is that any informed buyer of real estate would not pay more for a property than what it would cost to buy the land and build the structure.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The debt coverage ratio measures the degree to which the NOI from the property is expected to exceed the mortgage payment. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Debt Financing Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

CPI adjustments shift the risk of unexpected inflation to the lessor. ⊚ true ⊚ false

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3) Expense stops shift the risk of increases in expenses to the lessee while allowing the lessor to retain the benefit of any decrease in expenses. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Topic : Projected Cash Flows Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

4) In making an investment decision, IRR analysis will lead to a different "go/no-go" decision than NPV analysis.

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⊚ ⊚

true false

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5) The equity dividend rate is an accurate measure of investment yield because it considers future cash flows. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Projected Cash Flows Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

The use of a CPI index in a lease contract shifts risk to the tenant. ⊚ true ⊚ false

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Expense stops protect the lessee from unexpected changes in market rents. ⊚ true ⊚ false

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A gross lease is riskier for the lessor than a net lease. ⊚ true ⊚ false

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The debt coverage ratio is used by lenders to indicate the riskiness of a loan. ⊚ true ⊚ false

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10) When calculating IRR, the projected cash flows are discounted such that they will equal the initial investment amount. ⊚ true ⊚ false

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11)

Property held as a personal residence cannot be depreciated. ⊚ true ⊚ false

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12) Residential property is depreciated over 27.5 years whereas nonresidential property is depreciated over 39 years. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Taxation Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

13) The deductibility of depreciation in calculating taxable income will usually cause the effective tax rate to be lower than the actual tax rate. ⊚ true ⊚ false

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14) When the sale of a passive activity produces a capital loss and unused passive losses from previous years remain, the unused losses can be used to offset any other source of income. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Taxation Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

15) If an individual actively participates in the management of a rental property, he may deduct the full amount of the passive activity losses from active income, regardless of his adjusted gross income. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Taxation Difficulty : 2 Medium Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

16) During a recessionary period, it is possible the amount of space that is absorbed by the market will be negative. ⊚ true ⊚ false

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17) Operating expenses associated with the maintenance and upkeep of a residential property are generally tax deductible. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Topic : Taxation Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 18) Which of the following is NOT one of the primary benefits of investing in real estate income property? A) Net Income—Dollars left over after collecting rent and paying expenses but before considering taxes and financing costs B) Property Sale—Expecting a price increase over a specified holding period increases investor return C) Diversification—Reducing overall risk to hold many types of investments D) Business cycles—Real estate income properties tend to generate higher incomes when other investments are in decline

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19)

Which of the following statements regarding equity is TRUE?

A) The amount of equity an investor has in a property may change over time if the property value and loan balance changes. B) The amount of equity an investor has in a property depends on the value of the equity the investor has in his or her other investments. C) The outstanding loan balance on the property does not affect the amount of equity an investor has in the property. D) All of the choices are true statements.

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20)

Which of the following statements is TRUE regarding an effective tax rate? A) It takes into account the effects of depreciation and time value of money. B) It measures the actual difference between the BTIRR and the ATIRR. C) It can be less than the actual marginal tax rate. D) All of the choices are true statements.

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21)

Which of the following statements is TRUE regarding the real estate industry? A) It is highly competitive. B) It is a relatively small market. C) It is relatively concentrated, with a few owners controlling most of the market in most

areas. D) All of the choices are true statements.

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22) A restaurant is for sale for $200,000. It is estimated that the restaurant will earn $20,000 a year for the next 15 years. At the end of 15 years, it is estimated that the restaurant will sell for $350,000. Which of the following would be MOST LIKELY to occur if the investor’s required rate of return is 15 percent? A) Investor would pursue the project. B) Investor would not pursue the project. C) Investor would pursue the project if the holding period were longer than 15 years. D) Not enough information provided to answer.

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23) A property produces a first year NOI of $100,000 which is expected to grow by 2 percent per year. If the property is expected to be sold in Year 10, what is the expected sale price based on a terminal capitalization rate of 9.5 percent applied to the eleventh year NOI? A) $1,308,815 B) $1,283,152 C) $1,263,158 D) $1,257,992

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24) A property that produces a first year NOI of $80,000 is purchased for $750,000. The NOI is expected to increase by 15 percent in the sixth year when some of the leases turn over. The resale price in Year 10 is expected to be $830,000. What is the net present value of the property based on the 10-year holding period and a discount rate of 9.5 percent? A) $87,433 B) $87,221 C) $95,294 D) $116,490

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25) A property is purchase for $15 million. Financing is obtained at a 75 percent loan-tovalue ratio with total annual payments of $1,179,000. The property produces an NOI of $1,400,000. What is the equity dividend rate (ratio of first year cash flow to equity)? A) 5.89% B) 9.33% C) 7.86% D) 8.64%

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26) A property that produces a level of NOI of $200,000 per year is expected to be sold in Year 5 for $2,000,000. If the property was purchased for $2,000,000, what percent of the IRR can be attributed to the operating income only? A) 10.0% B) 90.0% C) 37.9% D) 63.1%

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27) A property that produces an annual NOI of $100,000 was purchased for $1,200,000. Debt service for the year was $95,000 of which $93,400 was interest and the remainder was principal. Annual depreciation is $38,095. What is the taxable income? A) $5,000 B) $6,600 C) −$31,495 D) −$33,095

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28) An investor who has $75,000 in taxable income purchases a building that produces another $15,000 in taxable income. Given the following tax brackets apply, what is the investor’s marginal tax rate? Taxable Income $0 - $34,000 $34,001 - $82,150 Over $82,150

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Marginal Tax Rate 15% 28% 31%

A) 29.50% B) 29.57% C) 28.00% D) 31.00%

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29) A small office building is purchased of $1,200,000 with a balloon mortgage that is due at the end of Year 10. Payments are based on a 25-year amortization period. If one point was charged at closing, what annual amount can be deducted for tax purposes? A) $1,200 B) $480 C) $0 D) $800

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30)

Which of the following is the formula for the adjusted basis of a property? A) Original cost + capital improvements − accumulated depreciation B) Sales price − mortgage balance − sales costs C) Sales price − accumulated depreciation D) Original cost − mortgage balance − sales costs

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31) A property is sold for $5,100,000 with selling costs of 3 percent of the sales price. The mortgage balance at the time of sale is $3,600,000. The property was purchased 5 years ago for $4,820,000. Annual depreciation allowances of $153,016 have been taken. If the tax rate is 28 percent, what is the after-tax cash flow from sale of the property? A) $1,184,062 B) $969,840 C) $1,347,000 D) $1,097,218

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32) A property produces an after-tax internal rate of return of 12.24 percent. If the investor has a marginal tax rate of 31 percent, what is the before-tax equivalent yield? A) 8.45% B) 11.39% C) 16.03% D) 17.74%

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33)

Which of the following includes income from real estate classified as capital assets? A) Passive income B) Active income C) Portfolio income D) Passive activity income

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34)

Which of the following is FALSE regarding an expense stop?

A) All operating expenses are covered by the stop. B) The passthrough is based on the tenant’s percentage of total leasable area. C) Expenses to be included must be agreed upon and included in the lease. D) The stop is often based on the actual amount of operating expenses at the time the lease is signed.

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35)

Which of the following is FALSE regarding expense stops? A) Expense stops protect owners against increases in expenses. B) Expense stops are usually based on expenses during the first term of the lease. C) Expense stops can pass through expense savings to tenants. D) Expense stops provide some protection against inflation.

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36)

The minimum lenders typically require for DCR in the first year is: A) 0.8. B) 1.0. C) 1.2. D) 1.5.

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37)

Which of the following is FALSE regarding DCR?

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A) It indicates whether NOI is sufficient to cover mortgage payments. B) It is not of concern to lenders when loan to value ratios are low. C) It is an indication of risk for the lender. D) It is derived from NOI divided by the mortgage payment.

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38) Net sale proceeds less the adjusted basis of the property determines which of the following? A) After-tax net present value of the property B) Depreciation allowance for the property C) Before-tax net present value of the property D) Capital gains or losses

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39) The general investment strategy based on a goal of acquiring existing, seasoned, relatively low-risk properties that are at least 80 percent leased to tenants with low credit risk, is: A) opportunistic investing. B) core strategy. C) core "Plus" strategy. D) value added strategy.

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40) The rate that causes the present value of all cash inflows to equal the initial investment of a project is referred to as the: A) NPV. B) payback period. C) TVM. D) IRR.

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Answer Key Test name: Ch11 1) TRUE A common measure of risk is the debt coverage ratio (DCR). The DCR is the ratio of NOI to the mortgage payment. 2) FALSE CPI adjustments shift the risk of inflation changes to the lessee. 3) TRUE Expense stops are a form of risk shifting whereby the lessor retains the benefit of expense decreases but shifts the risk of increases to the tenant. 4) FALSE The IRR and NPV analysis methods should result in the same decisions. 5) FALSE The equity dividend rate is not an investment yield because it does not take into account future cash flows from operation or sale of the property. 6) TRUE CPI adjustments shift the risk of inflation changes to the lessee. 7) FALSE Expense stops are a form of risk shifting whereby the lessor retains the benefit of expense decreases but shifts the risk of increases to the tenant. 8) TRUE Net leases are less risky for the lessor because total operating expenses pass through to the tenant. 9) TRUE A common measure of this risk is the debt coverage ratio (DCR). The DCR is the ratio of NOI to the mortgage payment.

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10) TRUE The IRR is the rate that equates the discounted projected cash flows to the initial investment. 11) TRUE Property held with the sole purpose of personal residency is not permitted to be depreciated for tax purposes. 12) TRUE According to current depreciation tables for investment properties, residential property is depreciated over 27.5 years and nonresidential property is depreciated for 39 years. 13) TRUE The reduction of taxable income by the depreciation expense typically results in a lower effective tax rate versus actual tax rate. 14) TRUE Extra passive losses can be used to offset other income sources for tax purposes. 15) FALSE The TRA phases out this special rule for individuals with adjusted gross incomes between $100,000 and $150,000. 16) TRUE The amount of space that is absorbed may be negative, indicating that less space is being occupied at the end of the year than at the beginning of the year. This often happens during the contraction phase of the business cycle, when companies are reducing the number of employees. 17) FALSE Operating expenses for properties held solely as personal residential properties cannot be deducted for tax purposes. 18) D

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Real estate property returns tend to follow other investments. For example, if the stock market is suffering a recession, the real estate market is also likely suffering from the recession impacts. 19) A The amount of equity is determined by property value and mortgage loan balances, so changes in these over time will impact the equity level. 20) D All of these are descriptive of the effective tax rate. 21) A Some underlying facts regarding the real estate industry are: (1) it is a very large market, in terms of both the number of properties and square footage, (2) it is highly competitive, and (3) ownership is highly fragmented, that is, no one owner or developer controls a significant share of the real estate market in major cities in the United States. 22) B PMT FV NPER PV Rate

$ 20,000 $ 350,000 15 $ (200,000) 12.01%

This is lower than the investor’s required rate of return. 23) B NOI, year 1 Growth Rate Years NOI, year 11 Cap Rate Sale Price

$ 100,000 2.0% 10 $ 121,899 9.50% $ 1,283,152

24) D The cash flows can be calculated as follows:

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Year 0 Purchase price

Years 1 to 5 Years 6 to 9

-$ 750,000

NOI

$ 80,000

$ 92,000

Sales price Cash flow

Year 10

$ 830,000 -$ 750,000

$ 80,000

$ 92,000

$ 922,000

Next, calculate the present value of the cash flows at a discount rate of 9.5 percent and sum the values as follows: Cash Flow Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 PV

Discounted@ 9.5%

-$ 750,000 $ 80,000 $ 80,000 $ 80,000 $ 80,000 $ 80,000 $ 92,000 $ 92,000 $ 92,000 $ 92,000 $ 922,000

-$ 750,000 $ 73,059.36 $ 66,720.88 $ 60,932.31 $ 55,645.94 $ 50,818.21 $ 53,370.73 $ 48,740.39 $ 44,511.77 $ 40,650.02 $ 372,040.08 $ 116,490

25) A NOI Debt Service

1,400,000 1,179,000 221,000

Purchase Price

15,000,000

Mortgage (at 75% LTV)

11,250,000

75%

3,750,000 Equity Dividend Rate

5.89%

26) C Years

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5 21

Purchase Price NOI

$ (2,000,000) $ 200,00 0

$ 200,00 0

Sale Price

Cash Flow

$ (2,000,000)

IRR NVP,operation s NVP,sale

$ 200,00 0

$ 200,000 $ 2,000,00 0 $ 2,200,00 0

10.00% $ 758,157.35 $ 1,241,842.6 5

37.91% 62.09%

$ 2,000,000.0 0

27) C NOI Interest Depreciation

100,000 93,400 38,095

Taxable Income

(31,495)

28) D $75,000 + $15,000 = $90,000. This is higher than $82,150 and so the marginal tax rate is 31 percent. 29) A $1,200,000 × 1% = $12,000 $12,000 / 10 = $1,200 30) A The adjusted basis is the original cost of the property plus the capital improvements minus accumulated depreciation. 31) D Version 1

Step 1: Calculate the net sales proceeds: $5,100,000 – ($5,100,000 × 3%) − $3,600,000 = $1,347,000. Step 2: Calculate the adjusted basis: $4,820,000 − ($153,016 × 5) = $4,054,920. Step 3: Calculate the tax on the capital gain: $5,100,000 – ($5,100,000 × 3%) − $4,054,920 = $892,080 × 28% = $249,782. Step 4: Determine the after-tax cash flow from the sale as $1,347,000 − $249,782 = $1,097,218. 32) D The before-tax equivalent yield = 0.1224 / (1 − 0.31) = 0.1774, or 17.74% 33) C Portfolio income includes interest and dividend income from stocks, bonds, and some categories of real estate that are classified as capital assets. 34) A The lessor and lessee must agree upfront to the costs that will be included in the stop. 35) C Expense savings are assumed by the lessor in an expense stop. 36) C Lenders typically want the first-year debt coverage ratio to be at least 1.2. 37) B Lenders typically want the first-year debt coverage ratio to be at least 1.2 regardless of the LTV. 38) D Capital gains or losses are determined by the net sales proceeds minus the adjusted cost basis. Version 1

39) B The core investment style is based on a goal of acquiring existing, seasoned, relatively low-risk properties that are at least 80 percent leased to tenants with low credit risk. 40) D The IRR is the rate that equates the present value of all cash inflows with the initial investment cost.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Financial leverage is defined as benefits that may result to an investor by borrowing money at a rate of interest that is lower than the expected rate of return on total funds invested in a property. ⊚ true ⊚ false Question Details Topic : Financial Leverage Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy

2) To determine whether leverage is positive or negative, the investor needs to determine whether the IRR is greater than the market rate of interest on mortgage loans. ⊚ true ⊚ false Question Details Topic : Financial Leverage Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

One benefit of leverage is that it reduces the variation in returns or losses. ⊚ true ⊚ false

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4) One benefit of leverage is that it may allow an investor to diversify across several investment properties. ⊚ true ⊚ false Question Details Topic : Financial Leverage Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

5) One advantage of a sale-leaseback is that the lease payments are 100 percent tax deductible. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Sale-leaseback Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy

One advantage of using leverage is that NOI increases with higher amounts of leverage. ⊚ true ⊚ false

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7) When the internal rate of return on an investment increases as the loan-to-value ratio increases, positive leverage exists.

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⊚ ⊚

true false

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If a property has positive leverage, the owner should borrow as much as possible. ⊚ true ⊚ false

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9) In an inflationary environment where property values are also rising, a participation loan may provide a lender with some protection against unanticipated inflation. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Participation Loans Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

10) An interest-only loan will provide a higher debt coverage ratio than an amortizing loan with the same interest rate. ⊚ true ⊚ false

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11) Everything else equal, the loan balance on a negative amortization loan will be less than that on an interest-only loan after the first year. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Accrual loans Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy

12) When constructing a convertible mortgage, the lender will require a contract interest rate equal to or greater than the market rate on a similar mortgage without a conversion option. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Convertible Mortgages Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

13)

The loan alternative with the highest ATIRR will always be preferable to the borrower. ⊚ true ⊚ false

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14) Properties with a higher ratio of debt are considered to also have a higher risk assuming everything else is equal. ⊚ ⊚

true false

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15) If a property owner borrows money at a rate that is higher than the equity yield rate, negative leverage exists. ⊚ true ⊚ false Question Details Topic : Financial Leverage Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

16) A loan in which the lender receives part of the proceeds from the sale of the property is known as a convertible loan. ⊚ true ⊚ false

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17) A decrease in financial leverage would be expected to magnify the risk and the potential return of an income-producing property. ⊚ true ⊚ false Question Details Topic : Financial Leverage Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 18) An investment has the following characteristics: ATIRRP: After-tax IRR on total investment in the property: 9.0% BTIRRE: Before-tax IRR on equity invested: 17% BTIRRP: Before-tax IRR on total investment in the property: 12% t: Marginal tax rate: 0.40 What would be the break-even interest rate (BEIR) at which the use of leverage is neither favorable nor unfavorable? A) 15.0% B) 20.0% C) 22.5% D) 28.3%

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19)

Under which conditions would one be MOST LIKELY to see an interest rate swap?

A) A borrower wants a fixed rate loan, but the bank only offers floating rate loans; the borrower "swaps" loans with someone who has a fixed rate loan. B) A borrower does not have enough equity for a conforming loan, so he or she takes out a "second" mortgage loan. C) A borrower does not have enough equity for a conforming loan, so he or she "swaps" mortgage insurance for increased equity investment. D) A bankruptcy court orders a lender to "swap" a debtor's high interest rate for a lower interest rate.

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20) A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $60,000, what is the maximum amount of debt service the lender would allow? A) $30,000 B) $50,000 C) $60,000 D) $72,000

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21) All other things being equal, which of the following best describes the effects of leverage on an investment’s risk-return characteristics (assuming the expected return is greater than the lending rate)? A) Lower expected return, lower risk B) Lower expected return, higher risk C) Higher average return, higher risk D) Higher average return, lower risk E) Risk-return characteristics have no role in investment decisions.

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22) A property is financed with a 75 percent loan at 11.5 percent over 25 years. The property produces an ATIRR on total investment of 7.34 percent based on a tax rate of 31 percent. What can be said about the leverage associated with the property? A) Negative leverage exists. B) Positive leverage exits. C) No leverage exists. D) Leverage cannot be determined without knowing the ATIRR on equity.

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23) A property produces an 8.92 percent ATIRR on the total investment considering a tax rate of 28 percent. What is the maximum interest rate that could be paid on debt without causing the leverage to be negative? A) 12.39% B) 11.42% C) 6.42% D) 9.37%

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24) A loan in which the lender receives a percentage of the net operating income from the property is known as a(n): A) participation loan. B) accrual loan. C) convertible loan. D) percentage loan.

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25) A loan in which the lender has an option to purchase an equity interest in a property is known as a(n): A) participation loan. B) accrual loan. C) convertible loan. D) percentage loan.

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26) Which of the following would NOT be considered an advantage that an investor might consider under a sale-leaseback of land? A) The sale-leaseback in effect provides 100 percent financing on the land. B) Lease payments are tax deductible. C) The sale-leaseback provides the same depreciation deductibility with a smaller equity investment. D) The land may appreciate over the holding period.

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27)

Which of the following is also referred to as a negative amortization loan? A) Participation loan B) Accrual loan C) Convertible loan D) Interest-only loan

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28) A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a property is $45,000, what annual amount of debt service would provide the required debt coverage ratio? A) $37,500 or higher B) $37,500 or lower C) $54,000 or higher D) $54,000 or lower

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29) If properly constructed, and assuming everything but the structures of the interest payments are equal, which of the following loans would typically have the highest first-year debt service? A) Accrual loan B) Conventional loan C) Interest-only loan D) Participation loan

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30) A property is financed with an 85 percent loan-to-value ratio at 10 percent interest over 25 years. What would be the estimated BTIRRE on equity given that the BTIRRp is 10.75 percent? A) 10.1% B) 10.4% C) 15.0% D) 13.2%

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31)

Which of the following typically would NOT be used as a basis for a participation loan? A) Increase in value over the holding period B) Reaching headcount reduction targets C) Cash flow after regular debt service D) Potential gross income

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32)

Which of the following is FALSE regarding interest-only loans? A) They usually have balloon payments. B) They have greater amortization than conventional loans. C) They may result in more cash flow to the investor. D) They may allow for a lower DCR.

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33) Which of the following gives the lender an option to purchase a full or partial interest in the property at the end of some specified period of time? A) Convertible loan B) Sale-leaseback C) Accrual loan D) Interest-only loan

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34)

Which of the following is FALSE regarding negative amortization? A) It can result in a decrease to the borrower’s equity in the property. B) It usually increases default risk. C) It usually has a lower interest rate than a conventional loan. D) It usually results in a lower DCR.

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35) Lenders for income-producing properties refer to loans that are short term and require little or no amortization as:

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A) missile loans. B) straight loans. C) ARM loans. D) bullet loans.

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36) The maximum interest rate that could be paid on a debt before the leverage becomes unfavorable is referred to as the: A) incremental cost of debt. B) break-even interest rate. C) favorable interest rate. D) optimistic interest rate.

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Answer Key Test name: Ch12 1) TRUE This is the definition of financial leverage. Positive financial leverage includes the benefits that may result for an investor who borrows money at a rate of interest lower than the expected rate of return on total funds invested in a property. 2) FALSE The determination of positive or negative leverage depends on the before-tax IRRs on equity, debt, and total investment. 3) FALSE Leverage magnifies the variation in returns or losses. 4) TRUE Leverage allows the investor to have access to additional resources, which increases the investment diversification possibilities. 5) TRUE In a sale-leaseback, all lease payments are tax deductible. 6) FALSE Because the NOI does not change when more debt is used, increasing the amount of debt increases the debt service relative to the NOI. 7) TRUE We can determine that positive leverage conditions are met when an increase in the LTV corresponds to an increase in the IRR. 8) FALSE

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Other factors should be considered. For example, increased borrowing leads to increased risks. Also, there may be a limit by the lender on the debt coverage ratio. 9) TRUE The par-ticipation provides the lender with a hedge of sorts against unanticipated inflation because the NOI and resale prices for an income property often increase as a result of inflation. 10) TRUE In an interest-only loan, the mortgage payment is just sufficient to cover the interest charge, so the payment will be lower than that of an amortizing loan payment. Therefore, the interest-only loan will have a higher debt coverage ratio. 11) FALSE Negative amortization loans have payments at the beginning that are lower than the amount that would be required to cover the monthly interest in the interest-only loan, so the loan balance after the first year will not be less than that of the interest-only loan. 12) FALSE The convertible feature provides an “option” for the lender, so the lender will be willing to accept a lower-than-market interest rate to acquire this option. 13) FALSE ATIRR is the after-tax interest rate. A higher rate will result in higher interest payment for the borrower. 14) TRUE Debt magnifies risk, so higher debt results in higher risk, all else held equal.

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15) TRUE Negative leverage exists when the before-tax IRR on equity is less than the before-tax IRR on debt. 16) FALSE A convertible mortgage gives the lender an option to purchase a full or a partial interest in the property at the end of some specified period of time. 17) FALSE Increases in leverage increase risk and potential return. 18) A BEIR = (ATIRRP / (1 −t)) = (0.09 / (1 − 0.4)) = 0.15, or 15% 19) A Should borrowers not want a floating rate, interest rate swaps may be used to achieve the equivalent of a fixed interest rate. 20) B ($60,000/1.2) = $50,000 21) C Leverage increases both return potential and risk. 22) A The BTIRR = (0.0734/(1 − 0.31)) = 0.1064, or 10.64%. Since this rate is lower than the cost of debt of 11.5 percent, we know that negative leverage exists. 23) A 8.92%/(1 − 28%) = 12.39% 24) A

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A participation loan in one in which, in return for a lower stated interest rate on the loan, the lender participates in some way in the income or cash flow from the property. 25) C A convertible mortgage gives the lender an option to purchase a full or a partial interest in the property at the end of some specified period of time. 26) D The investor no longer owns the land in a sale-leaseback, so land appreciation would not benefit the investor. 27) B Accrual and negative amortization are labels used interchangeably to describe loans that are structured so the payments for a specified number of years are lower than the amount that would be required to cover the monthly interest charge. 28) B The debt service would need to be equal to or lower than $45,000/1.2 = $37,500. 29) B The conventional loan would have the highest first-year debt service. The other listed loan types are structured to have lower debt service payments early in the loans. 30) C Use the formula BTIRRE = BTIRRP + ( BTIRRP − BTIRRD)(D/E). Here, D/E = 0.85/(1 − 0.85) = 5.67. So, = 0.1075 + 0.0075 × 5.67 = 0.150, or 15.0% 31) B Version 1

The amount of participation can be determined in many ways. For example, the lender might receive a percentage of one or more of the following: (1) potential gross income, (2) net operating income (NOI), and (3) cash flow after regular debt service (but before the participation). In addition, there might be a participation at the time the property is sold based on total sale proceeds or the appreciation in property value since it was purchased. 32) B Interest-only loans are not amortized. 33) A A convertible mortgage gives the lender an option to purchase a full or a partial interest in the property at the end of some specified period of time. 34) C The lender requires a higher interest rate to compensate for the negative amortization benefit that the borrower gets, so interest rate is higher versus a conventional loan. 35) D Lenders for income-producing properties refer to these loans as bullet loans because they are short term and require little or no amortization. 36) B Break-even interest rates represent the interest rate at which the leverage is neu-tral (neither favorable nor unfavorable).

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Partitioning the internal rate of return is useful because it helps the investor to determine how much of the return is from annual operating cash flow and how much is from the projected resale cash flow. ⊚ true ⊚ false Question Details Topic : Partitioning IRR Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy

2) In general, investors are assumed to be risk seekers who must be compensated more for the higher risk of some investments. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy Topic : Risk &amp; Return

Financial risk increases as the amount of debt increases. ⊚ true ⊚ false

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Real estate that is not leveraged is not affected by interest rate risk.

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⊚ ⊚

true false

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium Topic : Risk &amp; Return

Real estate is generally dramatically affected by inflation risk. ⊚ true ⊚ false

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium Topic : Risk &amp; Return

Use of leverage always increases the amount of business risk. ⊚ true ⊚ false

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy Topic : Risk &amp; Return

The range of returns (highest to lowest) is the most common risk measure. ⊚ true ⊚ false

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The term "due diligence" refers to conducting an investigation before buying a property. ⊚ true ⊚ false

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy Topic : Risk &amp; Return

Land can be viewed as having an "option" to develop the land. ⊚ true ⊚ false

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10)

Percentage rent is common in office building leases. ⊚ true ⊚ false

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11)

The term "financial risk" refers to the probability of interest rates changing. ⊚ true ⊚ false

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12) In general, real estate is usually considered more risky than bonds but less risky than stocks. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium Topic : Risk &amp; Return

13) A property with a higher standard deviation and a higher return is preferable to a property with a lower standard deviation and a lower return. ⊚ true ⊚ false

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Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium Topic : Risk &amp; Return

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 14)

Consider risk-return characteristics of Investments A-D, given above. Which of the following statements is TRUE? A) Investment C is preferred to Investment D. B) Investment D is preferred over all other investments. C) Investment A is preferred to Investment B. D) Investment B is preferred to Investment C.

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Question Details Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Difficulty : 1 Easy Topic : Risk &amp; Return

15) Consider two investments: Investment 1 has a 50 percent chance of producing a return of zero and a 50 percent chance of producing a return of 40 percent. Investment 2 has a 50 percent chance of producing a return of 10 percent and a 50 percent chance of producing a return of 30 percent. Which of the following statements regarding the investments is TRUE? A) Investment 1 is riskier than Investment 2. B) Investment 2 is riskier than Investment 1. C) Investment 1 and Investment 2 have the same amount of risk. D) Investment 1 is a better investment because it has the potential to produce the highest returns.

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium Topic : Risk &amp; Return

16)

Which of the following is NOT a component of lease rollover risk? A) Commissions paid to a leasing agent to find a new tenant B) Costs of tenant improvements demanded by new tenants C) Liquidity risk D) Reduced revenues from vacancy until a new tenant is found

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Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Lease Rollover Risk Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Difficulty : 3 Hard

17) Consider an investment in which a developer plans to begin construction of a building that will cost $1,000,000 in one year if, at that point, rent levels make construction feasible. There is a 50 percent chance that NOI will be $160,000 and a 50 percent chance that NOI will be $80,000. Using the traditional approach, which is similar to the "highest and best use" approach, what will the land value of the property be at the completion of the construction, assuming a cap rate of 10 percent (12 percent discount rate and an NOI growth rate of 2 percent)? A) $120,000 B) $200,000 C) $300,000 D) $833,333

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Traditional Approach to Land Valuation Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Difficulty : 3 Hard

18) Consider an investment in which a developer plans to begin construction of a building that will cost $1,000,000 in one year if, at that point, rent levels make construction feasible. There is a 50 percent chance that NOI will be $160,000 and a 50 percent chance that NOI will be $80,000. Assuming a cap rate of 10 percent (12 percent discount rate and an NOI growth rate of 2 percent) what would the land value be at the completion of the construction under the real options approach?

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A) $120,000 B) $200,000 C) $300,000 D) $833,333

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Real Options Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Difficulty : 3 Hard

19)

Risk due to potential tax law changes is referred to as: A) business risk. B) financial risk. C) legislative risk. D) tax risk.

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy Topic : Risk &amp; Return

20) When an investor performs an investigation while considering acquisition of a property, this is referred to as: A) investigation. B) risk analysis. C) due diligence. D) acquisition analysis.

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21) Which of the following refers to the risk real estate investors face stemming from changes in general economic conditions? A) Financial risk B) Liquidity risk C) Environmental risk D) Business risk

Question Details Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy Topic : Risk &amp; Return

22)

Which of the following BEST describes the process of "partitioning the IRR"?

A) Dividing the IRR into income and appreciation components B) Using the IRR as a discount rate and determining how much of the present value comes from income and resale C) Dividing the IRR into before-tax and after-tax IRRs D) Determining how much of the IRR comes from each property in a portfolio

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23) When sales exceed a breakpoint sales volume in a retail lease with percentage rent, the additional rent is referred to as: A) retail rent. B) participation rent. C) overage rent. D) sales rent.

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Percentage Rent Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy

24) Which of the following may be used as a market leasing assumption (including a renewal probability) in an analysis related to a lease renewal? A) Market rent paid after the existing lease ends. B) Vacancy after the existing lease ends. C) Leasing commissions paid after the existing lease ends. D) All of the choices are correct.

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25) If the renewal probability for a lease is assumed to be 60 percent and the number of months vacant would be 12 months if the lease is not renewed, what is the expected vacancy at the end of the lease? A) 4.8 months B) 7.2 months C) 9.0 months D) 12.0 months

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Market Leasing Assumptions Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Difficulty : 3 Hard

26)

Which of the following best describes the approach to valuing land as a "real option"?

A) The land value reflects the fact that the developer can wait to decide whether to construct a building on the site. B) The seller provides the investor with an option to purchase the land at a specific price before a certain date. C) The land is valued at its most probable use. D) The seller has an option to repurchase the land from the buyer before construction takes place.

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Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Real Options Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

27)

Which of the following is an example of a "real option" in an investment decision? A) Valuation of vacant land. B) Valuation of projects with phases of development. C) Valuation of a building that can be renovated. D) All of the choices are correct.

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Real Options Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand Difficulty : 2 Medium

28) An investor is analyzing the risk of a possible investment by producing three different scenarios. Under a pessimistic scenario, the property would produce a BTIRRp of 8 percent; a most-likely scenario would produce a BTIRRp of 12 percent; and an optimistic scenario would produce a BTIRRp of 16 percent. The investor assigns the pessimistic scenario a 25 percent chance of occurring, the most-likely case a 60 percent chance of occurring, and the optimistic scenario a 15 percent chance of occurring. What is the standard deviation of the returns? A) 0.062% B) 1.248% C) 2.498% D) 2.904%

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Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Sensitivity Analysis Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply Difficulty : 3 Hard

29)

Which of the following increases with use of leverage in a business? A) Financial risk B) Liquidity risk C) Environmental risk D) Inflation risk

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30) Which of the following would be most suitable for use in analyzing the best-case, worstcase, and most-likely outcomes for a potential investment opportunity? A) Risk analysis B) Financial analysis C) Sensitivity analysis D) Cost analysis

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31) A property owner may incur some downtime due to the expiration of a lease that has not been renewed. The time period that occurs before the owner can contract with a new tenant is referred to as: A) absentia turnover. B) market turnover. C) lease turnover. D) vacancy turnover.

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Market Leasing Assumptions Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember Difficulty : 1 Easy

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Answer Key Test name: Ch13 1) TRUE It is helpful to “partition” the rate of return to obtain some idea as to the relative weights of the components of the return and some idea as to the timing of the receipt of the largest portion of that return. 2) FALSE All investors are assumed to be risk averse, which means that they require a higher expected return as compensation for incurring additional risk. 3) TRUE Increased leverage leads to increased financial risk. 4) FALSE Even if an existing investor has a fixed-rate mortgage or no mortgage, an increase in the level of interest rates may lower the price that a subsequent buyer is willing to pay. 5) FALSE Real estate has historically not experienced extreme swings due to inflation. 6) TRUE Increased leverage results in increased financial, and thus business, risk. 7) FALSE Sensitivity analysis, standard deviation, and variance are all common methods of measuring risk. 8) TRUE Version 1

The term due diligence is used in the real estate investment community to describe the investigation that an investor should undertake when considering the acquisition of a prop-erty. 9) TRUE Empty land has the “option” to develop the land, as this is a choice and not a requirement. 10) FALSE Percentage rent is based on retail sales, so it is not a common feature of office building leases. 11) FALSE Financial risk is one type of risk that is due to the use of financial leverage. 12) TRUE Individual stocks are considered the most risky, with real estate next, followed by the least risky being investment in bonds. 13) FALSE The preference will depend on the investor’s risk tolerance and desired returns. 14) D Since Investments B and C have the same return but B has lower standard deviation, then B is preferred to C.

15) A Investment 1 Return 0 0.4

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Probility 0.5 0.5

Return × Probility 0 0.2

R − Exp R −0.2 0.2

Probility × (R − Exp R)2 0.02 0.02

Exp R

0.2

Variance

0.04

Investment 2 Return 0.1 0.3

Probility

Return × Probility 0.05 0.15 0.2

0.5 0.5 Exp R

R − Exp R

Probility × (R − Exp R)2 −0.1 0.005 0.1 0.005 Variance 0.01

The variance for Investment 1 is higher than that of Investment 2. 16) C Liquidity is not a risk when a lease ends and the owner must find another tenant. 17) B Probability

NOI

50%

160,000

Probability × NOI 80,000

50%

80,000

40,000 120,000 10% cap rate

Value of building Cost of construction Land value

1,200,000 1,000,000 200,000

18) C Year 1 value if NOI is $160K = $600K; Year 1 value if NOI is $80K = $0; So, land value = (0.50 × $600K) + (0.50 × $0K) = $300,000. 19) C Legislative risk results from the fact that changes in regulations can adversely affect the profitability of the investment. Version 1

20) C The term due diligence is used in the real estate investment community to describe the investigation that an investor should undertake when considering the acquisition of a prop-erty. 21) D The business risk is risk of loss due to fluctuations in economic activity that affect the variability of income pro-duced by the property. 22) B The act of “partitioning” the rate of return helps to obtain some idea as to the relative weights of the components of the return and some idea as to the timing of the receipt of the largest portion of that return. It is achieved by using the IRR as the discount rate and then determining how much of present value is due to income and how much is due to resale. 23) C The overage rent is the amount that exceeds the breakpoint sales. 24) D All of these elements are key factors to consider in the cost of lease renewal. 25) A (1 − 60%) × 12 = 4.8 months 26) A Empty land has the “option” to develop the land, as this is a choice and not a requirement. 27) D All of these represent options that the investor may elect to pursue but is not obligated to pursue, so they are all real options.

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28) C Return Pessimi 0.0 stic 8 Most0.1 likely 2 Optimis 0.1 tic 6

Probility 0. 25 0. 6 0. 15

Return × Probility 0.0 2 0.0 72 0.0 24 Exp 0.1 R 16

R − Exp R −0.0 36 0.00 4 0.04 4 Varian ce Standard deviation

Probility × (R − Exp R)2 0.00 032 0.00 001 0.00 029 0.00 062 0.02 498

29) A Increased leverage results in increased financial risk. 30) C One of the most straightforward ways of analyzing risk is to perform a sensitivity analysis, or a what-if analysis, of the property. This involves changing one or more of the key assumptions for which there is uncertainty to see how sensitive the investment per-formance of the property is to changes in that assumption. 31) D Typically, when a lease expires and is not renewed, the building owner will suffer some downtime until a new tenant is found and therefore will experience vacancy for a period of time. This is sometimes referred to as turnover vacancy.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) One factor an investor should consider when trying to decide whether to dispose of a property he or she has owned for several years is the expected IRR for holding versus sale of the property. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

Increasing rents tend to increase the marginal rate of return on a property. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

3) A property should be sold when the marginal rate of return rises above the rate at which funds can be reinvested. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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4) One disadvantage of refinancing a property instead of selling the property is that taxes must be paid on funds received by additional borrowing, but no taxes would have to be paid if the property is sold. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

Equity buildup represent the opportunity costs of keeping a property. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

6) When evaluating the incremental costs of borrowing, if the interest rate is higher on the larger loan amount, the incremental cost of the additional funds borrowed tends to be lower than the rate on the larger loan. ⊚ true ⊚ false Question Details Topic : Disposition Decisions Topic : Rate of Return Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

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7) The benefits of equity buildup in a property are lessened over time because with an amortizing mortgage, an investor will lose some tax benefits each year as the interest portion of the payments decreases. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Equity Buildup Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

8) An investor purchased a property expecting to receive a 14 percent rate of return. However, the rate of return on the property over a 5-year holding period turned out to be only 11.5 percent. Therefore, the property should be sold. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

9) Given the same expectations for future rents and expenses, a new buyer may earn a different after-tax return than the current owner of the same property. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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10)

In general, equity buildup tends to lower the marginal rate of return of holding a property. ⊚ true ⊚ false

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11) An investor calculates an incremental return of renovating a building of 14 percent. Other properties provide a 12.5 percent overall rate of return to equity investors. Therefore, the property is a good investment. ⊚ true ⊚ false Question Details Topic : Rate of Return Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

12) If a real estate tax law becomes more favorable, this generally benefits existing investors over new investors. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : RE Taxes Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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13) The marginal rate of return on a property usually increases until the sale of the property. Equity buildup should always be avoided if possible. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Equity Buildup Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

14) A property should be sold when the marginal rate of return falls below the rate at which funds can be reinvested. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

15) For refinancing to be profitable, the effective cost of the debt must be less than the unlevered return on the projects being financed. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Rate of Return Topic : Refinancing Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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16) The investment foundation of a real estate investment is another name for the initial investment. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

17) If an investor is deciding whether to sell a property, his equity buildup in the existing property should be considered as an opportunity cost. ⊚ true ⊚ false Question Details Topic : Disposition Decisions Topic : Equity Buildup Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 18) The marginal rate of return for a property is the: A) APR on an incremental amount of borrowing. B) expected holding period return earned when the investor purchases the property. C) return earned on subprime property relative to prime property. D) return gained by holding the property for one additional year.

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Question Details Difficulty : 1 Easy Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

19)

Which of the following is NOT a typical benefit of renovating a property? A) Increasing rents B) Lowering vacancy C) Increasing operating expenses D) Increasing the future property value

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20) Consider the information in the table below. What is the marginal rate of return for keeping the property one additional year? If sold today Sale price Mortgage balance Capital gain tax Cash flow NOI over next year

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$ 2,500,000 1,000,000 112,500 $ 1,387,000

If sold next year $ 2,650,000 900,000 135,000 $ 1,615,000 $ 50,000

A) 1.6% B) 2.0% C) 3.2% D) 20.0%

Question Details Topic : Rate of Return Topic : Renovation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

21) Consider the information in the table below. What is the rate of return the investor would earn on the additional funds invested in renovating the property, assuming that the investor would not borrow any additional funds? After-tax cash flow from operations if renovated After-tax cash flow from operations if not renovated Incremental cash flow from operations Sale proceeds if renovated Sale proceeds if not renovated Incremental cash flow from sale Renovation costs

$ 75,000 − 60,000 $ 15,000 $ 2,500,000 2,250,000 $ 250,000 $ 250,000

A) 6.0% B) 16.0% C) 66.0% D) 106.0%

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22)

Consider the figure below. Which of the following does the dotted (vertical) line denote?

A) Incremental rate of return on additional borrowed funds B) Marginal rate of return C) Optimal holding period D) Optimal yield

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Question Details Topic : Disposition Decisions Topic : Rate of Return Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand

23) A property, if sold today, will provide the equity investor with $150,000 in cash flow after taxes. If the property is held, the annual after-tax cash flow received by the investor will be as follows: $18,000 for Years 1 to 5, $24,000 for Years 6 to 10. If held and sold in 10 years, the property is expected to provide $180,000 in after-tax cash flow to the investor. What should the investor do if she can receive a 14 percent rate of return by investing the sales proceeds today in a different project? A) Sell the property and invest proceeds in the second property B) Do not sell the property C) Renovate the property D) Cannot be determined without knowing the cash flow from the second property

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24) A property could be sold today to provide an after-tax cash flow from sale of $800,000. The current after-tax cash flow from operations is $20,000, which is expected to grow by 4 percent per year. If sold next year, the property is expected to provide an after-tax cash flow of $824,000. What is the marginal rate of return for holding the property for an additional year? A) 5.6% B) 2.6% C) 3.1% D) 9.3%

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25) Which of the following factors would NOT be considered when an investor is trying to decide whether to hold or sell a property at the end of Year 5? A) After-tax operating income in Year 5 B) After-tax cash flow from the sale in Year 5 C) After-tax cash flow from the sale in the future D) After-tax operating income after Year 5

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26) A property worth $16 million can be refinanced with an 80 percent loan at 9.5 percent over 20 years. The balance on the current loan is $12,148,566. Loan payments are $113,302 per month. The loan balance in 10 years will be $8,396,769. If the property is expected to be sold in 10 years, what is the incremental cost of refinancing? A) 9.71% B) 10.36% C) 12.42% D) 14.58%

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Question Details Difficulty : 3 Hard Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply

27) An investor is considering renovating a building. The total cost of renovation is expected to be $100,000, of which 75 percent can be borrowed. Given the after-tax cash flows to the equity investor as shown below, what is the incremental return from renovating?

ATCF after renovation ATCF-no renovation

9,200

10,000

12,000

14,000

316,000

10,000

10,200

10,440

10,680

160,900

A) 9.75% B) 10.14% C) 15.32% D) 12.67%

Question Details Difficulty : 3 Hard Topic : Rate of Return Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 3 Apply

28) Which of the following represents the formula for the annual marginal rate of return (MRR) when trying to decide whether to hold or sell a property (ATCFS equals the after-tax cash flow from sale and ATCFO equals the after-tax cash flow from operations)?

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A) MRR = [ATCFS (Year t + 1) + ATCFO (Year t + 1) − ATCFS (Year t) − ATCFO (Year t)]/ATCFS (Year t) B) MRR = [ATCFS (Year t + 1) − ATCFO (Year t + 1) + ATCFS (Year t)] /ATCFS (Year t) C) MRR = [ATCFS (Year t + 1) + ATCFO (Year t + 1) − ATCFS (Year t)]/ATCFS (Year t) D) MRR = [ATCFS (Year t + 1) + ATCFO (Year t + 1) + ATCFS (Year t)]/ATCFS (Year t)

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29) Which of the following would be considered when an investor is trying to decide whether or not to renovate a property? A) After-tax operating income before renovation B) The difference between future operating income if renovated and if not renovated C) After-tax cash flow from sale the year of renovation D) The mortgage balance on the property the year before renovation

Question Details Topic : Renovation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

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30) An investor is considering refinancing a property. The current mortgage has an interest rate of 8.75 percent and a mortgage balance equal to 45 percent of the property value due to amortization of the loan and some appreciation in value. However, the investor would like to refinance at an amount equal to 75 percent of the property value. He has found out that the property can be refinanced at a 75 percent loan-to-value ratio for 9.5 percent interest over 15 years. What can be said about the incremental cost of refinancing? A) It will be higher than 9.5 percent. B) It will be less than 9.5 percent. C) It will be equal to 9.5 percent. D) Nothing can be determined without additional information.

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31) An investor purchased a building in 1982 when the building could be depreciated over 15 years. Assume it is 1992 today. A new investor is interested in purchasing the building in 1992 when the depreciable life according to tax laws is 31.5 years. Assuming both investors are in the same tax bracket and that everything else is equal, what can be said about the after-tax cash flow received by the new investor as compared to the after-tax cash flow that would be received by the original owner of the building? A) The new investor will have a higher after-tax cash flow because the depreciation expense will be lower. B) The new investor will have a higher after-tax cash flow because the depreciation expense will be higher. C) Both investors will have to use the 31.5 year depreciable life after 1986 so the aftertax cash flow will be equal. D) The new investor will have a lower after-tax cash flow because the depreciation expense will be lower.

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Question Details Topic : RE Taxes Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

32)

The marginal rate of return can be defined as the: A) return that results from holding the property for one additional year. B) IRR the year the internal rate of return starts to decrease from holding the property. C) incremental return over a holding period resulting from renovating a property. D) rate of return at which the net present value equals zero.

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33)

Disposition when dealing with real estate means which of the following? A) The way a property fits in with its surroundings B) Refinancing the property C) Improving the property value D) Sale of the property

Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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34) The return calculated assuming the property is held for one additional year is referred to as the: A) after-tax cash flow from sale. B) marginal rate of return. C) reinvestment rate. D) institutional rate.

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35)

A property should be sold when which of the following occurs? A) The marginal rate of return is rising and higher than the reinvestment rate B) The marginal rate of return is constant C) The marginal rate of return is zero D) The marginal rate of return is falling and becomes equal to the reinvestment rate

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36)

Which of the following is NOT a benefit of refinancing?

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A) The investor can increase financial leverage B) It is an alternative to sale of the property C) Risk is decreased D) No taxes have to be paid on funds received by additional borrowing

Question Details Difficulty : 2 Medium Topic : Refinancing Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 2 Understand

37) A property sale in which the buyer may make payments over time instead of paying the full price at the time of purchase is referred to as a(n): A) like kind sale. B) carryover sale. C) equivalent investment sale. D) installment sale.

Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

38)

In a real estate transaction, gross profit divided by the contract price is referred to as the: A) net profit. B) operating profit. C) profit ratio. D) mortgage profit.

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Question Details Difficulty : 1 Easy Topic : Disposition Decisions Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Bloom's : Level 1 Remember

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Answer Key Test name: Ch14 1) TRUE The opportunity cost of selling that should be considered is the IRR of holding the property. 2) TRUE The marginal, or additional, return that can be achieved is highly positively impacted by increasing rents. 3) FALSE A property should be sold when the marginal rate of return falls below the rate at which funds can be reinvested. 4) FALSE The interest payments on the mortgage from refinancing are tax deductible. Also, selling a property results in a necessary tax payment if the property is sold at a gain. 5) TRUE Equity buildup represents funds that the investor could place in another investment if the current property were sold. This is the opportunity cost of not selling the property. 6) FALSE If the interest rate is higher on the larger loan amount, then the incremental cost of the additional funds borrowed tends to be higher than the rate on the larger loan. 7) TRUE

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The benefits of the increased equity ownership are offset by the decreasing tax benefits at the outstanding loan balance and, thus, interest tax deductions are reduced over time. 8) FALSE This decision should be based on the rate of return the investor could achieve through alternative investments. If this achievable rate does not exceed 11.5 percent, then the property likely should be kept. 9) TRUE The new buyer may be in a different tax bracket than the current owner, so the after-tax returns may differ. 10) TRUE The benefits of the increased equity ownership are offset by the decreasing tax benefits at the outstanding loan balance and, thus, interest tax deductions are reduced over time. 11) FALSE The rate of return should be compared to what the investor could achieve through alternative investments and not just versus other properties. 12) FALSE If the tax law becomes more favorable, as it did in 1981 when ACRS was passed and depreciable lives were shortened considerably, then new investors tend to be favored. 13) FALSE

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Equity buildup has benefits and disadvantages, but it should not always be avoided. Although this equity buildup may appear desirable in the sense that the investor will get more cash from the property when it is sold, it also means that each year the investor has more funds tied up in the property. Any increase in the value of the property over time, whether anticipated or not, also contributes to an increase in the investor’s equity buildup. 14) TRUE A property should be sold when the funds tied up in the property can be invested elsewhere and achieve higher returns. 15) TRUE Refinancing results in borrowing costs, so, for refinancing to be profitable, the effective cost of the debt must be less than the unlevered return on the projects being financed. 16) FALSE Another name for the initial investment is the investment base. 17) TRUE Equity buildup represents funds that the investor could place in another investment if the current property were sold. This is the opportunity cost of not selling the property. 18) D The marginal rate of return is defined as the return on the property from holding it for one more year. 19) C Renovating a property should result in lower operating expenses as upgrades should lead to lower maintenance costs. 20) D Version 1

Marginal return = (Cash flow if sold next year + NOI over next year − Cash flow if sold today) / Cash flow if sold today Marginal return = ($1,615,000 + $50,000 − $1,387,500) / $1,387,500 = 20.00%. 21) A This is equal to the incremental cash flow from operations if renovated divided by the renovation costs, so $15,000/$250,000 = 0.06, or 6.0%. 22) C The optimal holding period is the year at which the MRR curve crosses the reinvestment rate curve.

23) B First, we must determine the IRR of holding the property. Understand that the Year 0 “cash flow” is the opportunity cost of $150,000, which is the selling price that would be achieved if sold today. Using the =IRR spreadsheet function with cash flows as follows: Year 0 = 150,000; Years 1-5 = 18,000; Years 6-9 = 24,000; and Year 10 = 24,000 + 180,000 = 204,000; we find IRR = 14.37%. Comparing this to the 14 percent that can be earned by investing the sales proceeds today, we see that the rate that can be achieved by holding the property is higher, so the investor should not sell. 24) A Step 1: Calculate the after-tax cash flow from operation next year: $20,000 × 1.04 = $20,800. Step 2: Calculate the after-tax total cash flow from holding for one additional year: ($824,000 − $800,000) + $20,800 = $44,800. Step 3: Find the marginal rate of return from holding for one additional year: $44,800/$800,000 = 0.056, or 5.6%. 25) A

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The decision should be based on the current and future sale prices and future operating income. The current year operating income is not a factor in this decision. 26) C Step 1: Determine the new loan value: $16,000,000×0.8 = $12,800,000. Step 2: Calculate the monthly payments on the new loan: =PMT(0.095/12,20×12,−$12,800,000) = $119,312.79. Step 3: Calculate the balance of the new loan at the end of ten years: =FV(0.095/12,10×12,$119,312.79,−$12,800,000) = $9,220,637.10. Step 4: Calculate the differences between the new loan and existing loan for the current balances, the monthly payments, and the balance after ten years: $12,800,000 − $12,148,566 = $651,434 current balance difference; $119,312.79 − $113,302 = $6,010.79 monthly payment difference; $9,220,637.10 − $8,396,769 = $823,868.10 balance after ten years difference. Step 5: Use the amounts from Step 4 to calculate the incremental cost of financing: =RATE(10*12,$6,010.79,−$651,434,$823,868.10) = 0.103 × 12 = 0.1242, or 12.42%. 27) A Step 1: Calculate the difference between the ATCF after renovation and the ATCF without renovation. Note: We need to include the Year 0 cash flow of $100,000 required for renovation.

ATCF after renovation ATCF-no renovation Difference

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$ (100,000) $ 0

$ 9,200 $ 10,000 $ (800)

$ 10,000 $ 10,200 $ (200)

$ 12,000 $ 10,440 $ 1,560

$ 14,000 $ 10,680 $ 3,320

$ 316,000 $ 160,900 $ 155,100

$ (100,000)

Step 2: Calculate the IRR using the spreadsheet function =IRR, with the yearly cash flows set to the differences in each year. The result is 9.75 percent. 28) C The correct formula is MRR = [ATCFS (Yeart + 1) + ATCFO (Yeart + 1) − ATCFS (Yeart)]/ATCFS (Yeart) 29) B The difference between future operating income if renovated and if not renovated should be considered when determining whether to renovate. The after-tax operating income before renovation, the after-tax cash flow from sale the year of renovation, and the mortgage balance on the property the year before renovation is not used to determine whether or not to renovate. 30) A By refinancing, we obtain additional funds. If the interest rate on the new loan is higher than that on the existing loan, the incremental cost of the additional funds will be even higher than the rate on the new loan. The borrower would also need to consider any refinancing fees, which will increase the incremental cost of refinancing. 31) D The new investor will have lower annual depreciation charges because they must depreciate the property over a longer period of time. As a result, the new investor will have lower depreciation tax benefits, which will result in a lower after-tax cash flow. 32) A The return from holding a property for one additional year is the marginal rate of return of the property.

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33) D Disposition refers to selling an owned property. 34) B The return from holding a property for one additional year is the marginal rate of return of the property. 35) D When the marginal rate of return drops below the reinvestment rate, then the funds can be reinvested elsewhere at a higher return. 36) C Refinancing results in increased financial leverage, it creates an alternative to selling a property, and the additional borrowing is not taxed (in fact, there is a tax benefit of increased interest expense deductions from the higher mortgage). Refinancing does not lower one's risk. 37) D An installment sale occurs when the contract of sale provides that, instead of paying the full price when the property is purchased, the buyer shall make payments over time, or in installments. 38) C The profit ratio is defined as gross profit divided by the contract price.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) For a large corporation with a good credit rating seeking to finance corporate real estate, the cost of a mortgage loan may be greater than the cost of unsecured corporate debt. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

2) Because real estate is shown on the corporation’s books at its historical cost less book depreciation, the value of corporate real estate is often considered "hidden" from shareholders. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

3) Because real estate usually declines in value faster than accounting depreciation, it is reasonable to assume that the property has zero value at the end of the lease term. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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4) A company estimates that the incremental cost of owning a parcel of real estate vs. leasing will be 10 percent. The company expects a 12 percent rate of return on investments. Therefore, real estate should be owned and not leased. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

5) In general, if a company assumes that the residual value at the end of the holding period is always equal to the book value, the decision to own versus lease will be biased towards owning. ⊚ true ⊚ false Question Details Topic : Own vs. Lease Difficulty : 2 Medium Accessibility : Keyboard Navigation Topic : Residual Value Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

6) Similar to decisions about owning or leasing equipment, the decision to own or lease a property is basically just a choice between two financing alternatives. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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7) The residual value at the end of the holding period should be based on the market value of the real estate and not the book value. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Topic : Residual Value Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

8) Nonrecourse debt, such as a mortgage on a specific property, typically has a lower rate than the unsecured debt of companies with high credit ratings. ⊚ true ⊚ false Question Details Topic : Corporate RE Financing Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

For public companies, an operating lease does not affect a corporate balance sheet. ⊚ true ⊚ false

Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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10) Because accounting depreciation charges often exceed the true economic depreciation of real estate, the earnings of companies owning real estate typically understate the level of operating cash flow. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

11) A company can diversify its business activities by developing, owning, and subsequently leasing real estate to other companies. Because of the diversification benefits, shareholder value is always increased. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Diversification Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

12) If the incremental cash flows from owning versus leasing are compared without explicitly considering debt financing, these returns should be compared to the firm’s cost of equity. ⊚ true ⊚ false Question Details Topic : Own vs. Lease Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

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13) If a company’s space requirements are far less than what is optimal to develop on a given site, leasing would tend to be more favorable. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

14) If a company's management is unsure of how long it will need the use of a real estate asset, it is likely that the company will lease the property. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

15) If a company decides to lease a piece of real estate, it will typically arrange for offbalance-sheet financing for the payments since they will be tracked on the income statement and not on the balance sheet. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) For which of the following reasons would a business prefer to own real estate rather than lease it? A) Owning is better than leasing if the business demands specialized or unique facilities. B) Owning allows the business to develop skills in operating, maintaining, and repair of real estate and the associated facilities. C) Owning reduces operating flexibility. D) The capital commitments with owning are lower than the capital commitments associated with leasing.

Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

17) Why might it be argued that corporations do not have a comparative advantage when investing in real estate as a means of diversification from the core business? A) Corporations cannot react as quickly as individual investors to changes in market conditions. B) Corporations do not typically hold real estate in a large number of geographic areas and may not hold a variety of different types of properties. C) Corporations often use property managers who do not understand financial markets. D) Diversification dilutes a corporation’s risk-return profile and does not provide an advantage to corporations.

Question Details Topic : Corporate RE Financing Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

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18) A company is planning to move to a larger office and is trying to decide if the new office should be owned or leased. Cash flows for owning versus leasing are estimated as follows. Assume that the cash flows from operations will remain level over a 10-year holding period. If purchased, the company will invest $385,000 in equity and finance the remainder with an interest-only loan that has a balloon payment due in Year 10. The after-tax cash flow from sale of the property at the end of Year 10 is expected to be $750,000. What is the incremental rate of return on equity to the company if the property is owned instead of leased? Own

Lease

Sales Cost of goods sold Gross income Operating expenses:

1,000,000 500,000 500,000

Business Real estate Lease payments Interest Depreciation Taxable income Tax Income after tax Plus: Depreciation After-tax cash flow

130,000 60,000 0 90,000 35,000 185,000 55,500 129,500 35,000 164,500

130,000 60,000 120,000 0 0 190,000 57,000 133,000 0 133,000

A) 17.99% B) 13.26% C) 10.32% D) 12.62%

Question Details Difficulty : 3 Hard Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 3 Apply Accessibility : Screen Reader Compatible

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19) Which of the following factors does NOT represent an effect of corporate real estate ownership on corporate financial statements? A) The unrealized source of potential gain from the sale of property is not represented on annual income statements. B) Income represented on accounting statements may underestimate the actual cash flows provided by property. C) The book value of property on the balance sheet may not represent the actual market value. D) The corporation's overall debt ratio may be reduced, and property is carried at book value but financed at market value.

Question Details Topic : Corporate RE Financing Difficulty : 3 Hard Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 3 Apply Accessibility : Screen Reader Compatible

20) Which of the following conditions will NOT cause a lease to be categorized as a finance lease? A) It extends for at least 65 percent of the asset's life. B) It transfers ownership to the lessee at the end of the lease term. C) It contains a purchase option on the asset that is reasonably certain to be exercised. D) The present value of the contractual lease payments equals or exceeds 90 percent of the fair market value of the asset at the time the lease is signed.

Question Details Topic : Corporate RE Financing Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

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21) A company sells an office building that has appreciated in value and subsequently leases the space. Which of the following scenarios represents an impact that sale-leasebacks may have on corporate financial statements? A) Lower total income will be realized in the year of sale because of capital gains tax. B) Higher taxable income will be realized in the year of sale because of a gain on sale. C) Earnings per share increases because the mortgage has been paid off. D) Higher taxable income will be realized because lease payments cannot be deducted.

Question Details Difficulty : 2 Medium Topic : Sale-leaseback Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

22) Which of the following does NOT represent a potential benefit of selling and leasing back a property? A) Provides a source of capital B) Returns excess capital to investors C) Demonstrates the value of the real estate to the marketplace D) Increases the firm's depreciation deductions

Question Details Difficulty : 1 Easy Topic : Sale-leaseback Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

23)

The cash flows considered in a sale-leaseback analysis are:

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A) purchase price, differences in operating expenses over the holding period, and cash flow from future sale. B) purchase price, lease payments, and cash flow from future sale. C) cash flow from sale, differences in future cash flow from operations, and potential cash flow from future sale. D) cash flow from sale, future lease payments, and differences in future operating expenses.

Question Details Difficulty : 2 Medium Topic : Sale-leaseback Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

24)

The cash flows considered in a lease versus own analysis are:

A) purchase price, difference in cash flow from operations over the holding period, and cash flow from sale. B) purchase price, lease payments, and cash flow from future sale. C) cash flow from sale, differences in future operating expenses, and cash flow from future sale. D) cash flow from sale, future lease payments, and differences in future operating expenses.

Question Details Topic : Own vs. Lease Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

25) All other factors being equal, a company would prefer to own rather than lease under which of the following conditions?

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A) The expected life of an asset far exceeds the company's projected period of use. B) The real estate investment represents a large proportion of the company's total capital. C) The corporate needs for the property are not highly sensitive to the level of maintenance. D) The corporation needs a specialized research and development building.

Question Details Topic : Own vs. Lease Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

26) Which of the following is likely to be affected if a corporation acquires a parcel of real estate? A) Cash flow B) Corporate liquidity C) Corporate risk D) All of the choices are correct.

Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

27) It is estimated that corporate users control as much as __________ percent of all commercial real estate.

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A) 10 B) 25 C) 75 D) 100

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28) When doing a sale versus lease analysis, how should the residual value of the property be estimated? A) Assume it is worthless B) Set it equal to the book value of the property C) Assume it is equal to the original purchase price D) Assume it is equal to the market value of the real estate

Question Details Difficulty : 1 Easy Topic : Own vs. Lease Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

29) Which of the following statements is TRUE for a corporation with a high credit rating considering owning versus leasing corporate real estate?

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A) The company should probably use a mortgage. B) The company may be able to issue corporate debt at a more favorable rate than it could obtain with a mortgage. C) The company is probably better off leasing the property from someone with a lower credit rating. D) The company's credit rating does not affect the own versus lease decision.

Question Details Topic : Own vs. Lease Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

30)

Which of the following statements is FALSE regarding operating leases?

A) The present value of the lease payments exceeds 90 percent of the value of the leased asset are recorded as the present value of the lease on the balance sheet. B) They require recognition on the balance sheet for public companies. C) They must not extend for more than 75 percent of the asset's life. D) Ownership is not transferred to the tenant at the end of the lease term.

Question Details Topic : Corporate RE Financing Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

31) The real estate activities of firms that only use real estate as part of their business operations are commonly referred to as:

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A) corporate real estate. B) real estate analysis. C) business real estate. D) real estate finance.

Question Details Difficulty : 1 Easy Topic : Corporate RE Financing Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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Answer Key Test name: Ch15 1) TRUE A corporation with a high credit rating may pay less for unsecured debt than for a mortgage because the rate on mortgage loans, particularly those made without recourse to the borrower, reflects the risk of default, which is the inability of the cash flows produced by the property to service the debt rather than the default risk associated with the borrower. 2) TRUE The appreciation in value of some corporate real estate poses a critical problem for management. Many observers claim that: (1) because accounting conventions require companies to carry real estate assets on a lower of cost or market basis and (2) many properties contribute little to reported earnings, the value of corporate real estate is hidden from investors and, therefore, not fully reflected in stock prices. This is the problem of hidden value. 3) FALSE 4) FALSE When making the lease-versus-own decision, remember that the volume of sales and the operating costs associated with generating those sales will be the same whether the space is leased or owned. Therefore, the decision to lease or own should depend only on the difference in cash flows under the two alternatives. 5) FALSE

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Because real estate does not typically decline in value as fast as accounting depreciation and rarely has zero value at the end of a typical lease term, assuming no residual value or a residual value that is equal to the book value biases the lease-versus-own decision toward leasing. 6) FALSE In addition to having use of the real estate during the term of the lease, a corporation that chooses to own real estate has also made an investment in its residual value. This means that deciding between owning and leasing real estate is not simply a choice between two financing alternatives. 7) TRUE The correct approach is to make a realistic estimate of the residual value of the real estate and the uncertainty of the value estimate. This estimate should consider the market value of the real estate, not the investment value to the corporation. 8) FALSE In the case of nonrecourse financing, the rate on the mortgage includes a risk premium to the lender because the borrower has the option to default in the event that the property value is less than the loan or cash flow cannot service the debt. In such cases, the financial community may consider debt based on the assets of the corporation less risky than the real estate, and, therefore, the unsecured corporate borrowing rate may be lower than that of a mortgage loan based solely on the real estate as security. 9) FALSE

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The new accounting standards, which went into effect for public companies for the annual period beginning after December 15, 2018, require both an asset and liability to be recorded on the balance sheet for both operating and finance leases. 10) TRUE Because accounting depreciation charges generally exceed true economic depreciation, the reported earnings of real estate companies typically understate the level of operating cash flow. And if the market responds mechanically to reported earnings, then it could systematically undervalue real estate assets, thus leaving companies prey to raiders concerned only about cash flow. 11) FALSE Increased diversification does not necessarily increase shareholder value. If the diversification is into unprofitable assets, for example, then the shareholder value will decrease. 12) FALSE The incremental cash flows and the after-tax IRR should be considered. Whether these factors are sufficient to justify the additional investment in ownership versus leasing depends on the opportunity cost and risk associated with the investment of equity capital in the property. 13) TRUE Leasing is preferable when the company’s space requirements are far less than the optimal development on a given site. 14) TRUE

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In cases where the expected life of an asset far exceeds the company’s projected period of use, companies will also generally choose to lease rather than bear the costs associated with selling an illiquid asset. This tendency can be explained, in part, by the comparative advantage of lessors in creating or locating alternative uses for such assets. 15) FALSE The new accounting standards, which went into effect for public companies for the annual period beginning after December 15, 2018, require both an asset and liability to be recorded on the balance sheet for both operating and finance leases. 16) A Companies are more likely to own buildings that have been customized for their operations, especially when those operations are unusual and the company has few competitors. 17) B In today’s environment, corporate management are far more likely to question the traditional notion that corporations have a comparative advantage in owning real estate. It is important to remember that corporate real assets, while functioning as facilities in corporate operations, are part of local and regional property markets. And unless the company is a dominant force in a small local economy, the market value of those assets is typically governed by factors very different from those that drive the value of the firm’s operating business. 18) B $164,500

$133,000 PMT

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$ 31,500 18

PV FV NPER Rate

$ (385,000) $ 750,000 10 13.26%

19) D Corporate real estate ownership increases the debt ratio to the extent that financing is required to purchase the real estate. 20) A The lease term is primarily for the remaining economic life of the leased asset, that is, greater than 75 percent, not 65 percent. 21) B During the year of sale, the company will pay higher taxes given the gain on sale due to the appreciation in price. 22) D The firm will no longer be able to realize depreciation deductions since it no longer owns the property. 23) C The key factors to consider in determining whether to participate in a sale-leaseback are the potential cash flow from the sale in the future, the difference in future cash flow from operations, and the cash flow from sale today. 24) A The key factors in the own versus lease decision are the cash flow from sale today, the difference in cash flow from operations over the holding period, and the purchase price today. 25) D

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Companies are more likely to own buildings that have been customized for their operations, especially when those operations are unusual and the company has few competitors. 26) D Risk, liquidity, and cash flow are all impacted by the purchase of real estate. 27) C Corporations are very significant users of commercial real estate in the United States. Corporate users control as much as 75 percent of all commercial real estate according to some estimates. 28) D The residual value should be assumed to be the market value because this is the value that would be realized if the property were to be sold today. 29) B A corporation with a high credit rating may pay less for unsecured debt than for a mortgage because the rate on mortgage loans, particularly those made without recourse to the borrower, reflects the risk of default—the inability of the cash flows produced by the property to service the debt rather than the default risk associated with the borrower. 30) A In a financing lease, the present value of the lease payments is substantially all (i.e., greater than 90 percent) of the value of the leased asset. 31) A Because so many of these “user firms” are corporations, their real estate activities are commonly referred to as corporate real estate.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) One of the risks of project development is "project risks," which are the result of unexpected changes in general market conditions affecting the supply and demand for space. ⊚ true ⊚ false Question Details Topic : Project Development Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

2) In general, developers must get a construction loan before they can line up permanent (long-term) financing that will be used once the project is complete and is in operation with tenants. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

3) A take-out commitment is a construction loan that, in effect, becomes permanent financing when construction is complete. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Construction Loans Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

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4) Holdbacks are used by construction lenders to be sure that a developer has met all obligations before all of the funds from the construction loan are given to the developer. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Construction Loans Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

5) The demand for retail space should be examined in terms of the characteristics of the tenant's demand in a given market. ⊚ true ⊚ false Question Details Topic : Project Development Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

6) Construction loans provide the money to construct a building and are usually provided by life insurance companies or pensions funds. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Construction Loans Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

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7) Permanent loans generally provide the money to pay off the construction loan in segments as the work progresses. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Permanent Loans Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

8) Commitments for construction financing are usually contingent on commitments for permanent financing. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Construction Loans Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

Permanent financing commitments usually allow the lender to approve major leases. ⊚ true ⊚ false

Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Permanent Loans Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand

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10) Lenders typically finance the development of a project as a percentage of completed appraised value, including the price of the site. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand

11) Even after obtaining permanent financing, a developer still maintains the right to alter a project’s design or the level of expenditures. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Topic : Permanent Loans Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

12) Generally, as the cost of a site increases, so do the quality and the density of the improvements constructed on it. ⊚ true ⊚ false Question Details Topic : Project Development Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

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13) Loans made under the assumption that markets will turn around are referred to as spec loans. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand

14) A standby commitment differs from a permanent take-out commitment in that neither party really expects the standby commitment to be used by the developer. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Accessibility : Screen Reader Compatible Difficulty : 1 Easy Bloom's : Level 1 Remember

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 15) A permanent take-out commitment is: A) a way to increase NOI for projects with large debt service obligations. B) an agreement by a lender to provide permanent financing for a property once construction is complete, provided all of the contingencies have been met. C) another term for a construction loan. D) the same thing as an acquisition and development loan.

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16) Which of the following is one reason that construction lenders typically prefer the cost approach to valuation over the income approach? A) The cost approach provides a more conservative estimate of value. B) The cost approach provides a more optimistic estimate of value. C) The cost approach is a good indication of the expected value of an income-producing property once construction is complete and it has been leased up. D) The cost approach is a better estimate of actual market value of the project.

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17) Units Gross Revenue Vacancy Expenses Net Operating Income Cost

275 $ 3,267,000 163,500 1,143,450 $ 1,960,200 $ 22,000,000

300 $ 3,564,000 178,200 1,247,400 $ 2,138,400 $ 22,800,000

Consider the table above. An investor-developer demands a return of at least 9 percent on cost. Which of the following statements is TRUE based on the information above?

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A) Neither project produces a sufficient expected return. B) The 275-unit project produces a sufficient return, but the 300-unit project does not. C) The 300-unit project produces a sufficient return, but the 275-unit project does not. D) Both projects produce sufficient returns, but the 275-unit project produces a higher return than the 300-unit project.

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18)

Which of the following is the usual progression for a real estate development project? A) Land acquisition, completion, management, sale, construction B) Land acquisition, construction, completion, management, sale C) Land acquisition, construction, completion, sale, management D) Land acquisition, management, construction, completion, sale

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19)

Which of the following is a "soft cost" of construction? A) The cost of the architectural drawings B) The cost of pouring the foundation C) The cost of erecting the building D) The cost of finishing the interior space

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20) Permanent funding commitments usually contain many funding contingencies. Which of the following typically is NOT one of those contingencies? A) Approval of all employees hired to work at the site B) Approval of design changes or building material substitution C) Expected percentage of occupancy upon completion D) The expected date of project completion

21)

Permanent loans usually refer to financing:

A) at local coffers B) for the lease-up period C) for construction and all subsequent periods D) after construction is completed and after the occupancy of the property is said to be stabilized

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Question Details Accessibility : Keyboard Navigation Gradable : automatic Topic : Project Financing Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand

22)

The MOST common method of distributing funds provided by a construction loan is a:

A) single lump sum of money at the closing of the loan. B) single lump sum of money at the end of the construction project to reimburse the developer for the project's expenses and profit. C) series of payments throughout the construction project to reimburse the developer for costs incurred since the previous payment. D) series of payments throughout the construction project to reimburse the developer for anticipated expenses in the upcoming period.

23) In comparison to permanent financing, the rates and rate variability for a construction loan would be which of the following? Interest Rate (A) (B) (C) (D)

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High High Low Low

Interest Rate Variability Steady Fluctuating Steady Fluctuating

A) Option A B) Option B C) Option C D) Option D

24)

Interest on a construction loan is usually paid: A) upfront at the beginning of the loan. B) periodically over the life of the loan. C) in quarterly installments over the life of the loan. D) at the end of the loan.

25) Besides an estimate of costs, a construction loan submission package includes many other components. Which of the following is NOT one of those components?

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A) Two years of prior tax returns B) Current financial statements C) Pro forma operating statements D) Ratio and sensitivity analysis

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26)

In the context of a lease, percentage rents generally indicate that:

A) the tenant will pay a proportionate amount of rent for his space in comparison to the total net rentable area. B) in addition to a base rent, the lessor will receive a percentage of the tenant's cash flow above some break-even point. C) the tenant will pay a rent that is a certain percentage of the national average D) None of the choices are correct.

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27) Why would a developer be willing to manage a completed project even after it has been sold?

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A) The developer knows the project better than other management companies and, therefore, could manage the property more efficiently. B) The developer could profit from the lucrative management fees being charged by management companies. C) Knowledge of the tenant’s needs and the current leasing market might give the developer better insight with respect to future developments. D) All of the choices are correct.

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28) Which of the following is NOT one of the development strategies that may be used by developers? A) Selling and leasing back the land for the development. B) Owning and managing the real estate after sale. C) Selling the real estate after lease-up phase. D) Developing the real estate for lease in master-planned development.

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29)

Which of the following is FALSE regarding a construction loan?

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A) It usually has a lower rate than does permanent financing. B) It is also known as an interim. C) Hard costs can usually be financed. D) The entire land cost cannot usually be financed.

30) Which of the following common contingencies is NOT usually included with a permanent financing agreement? A) Completion date for construction phase B) Expected percentage of occupancy C) Materials used in construction phase D) Cleanliness of work area

31) What term applies to third-party financing that is used between funds advanced by the permanent lender and funds needed to repay the construction loan?

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A) Interim loan B) Mini-perm financing C) Gap financing D) Partial financing

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32)

Developers usually hold back about __________ percent of each progress payment. A) 1 B) 10 C) 25 D) 75

33) ADL lenders recognize that too much of which of the following may lead to significant overbuilding and an excess supply of space in a local market? A) Speculative, closed-ended construction lending B) Speculative, open-ended construction lending C) Planned, closed-ended construction lending D) Planned, open-ended construction lending

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34) When commercial banks consider construction loans, their analysis is generally based on which of the following? A) Hard and soft costs B) Hard costs, soft costs, and site location C) Hard costs, soft costs, and appraised value D) Hard costs and site location

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35) In determining whether a project is commercially viable given the prevailing market rents, land prices, and construction and financing costs, a developer would be likely to conduct a(n): A) feasibility analysis. B) submarket analysis. C) economic analysis. D) multivariate analysis.

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Question Details Topic : Project Development Accessibility : Keyboard Navigation Gradable : automatic Accessibility : Screen Reader Compatible Difficulty : 2 Medium Bloom's : Level 2 Understand

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Answer Key Test name: Ch16 1) FALSE Market risks result from unexpected changes in the general market conditions; project risks are specific to a given project. 2) FALSE The developer may provide the equity capital, or it may come from a partnership between the developer and the landowner or other investors. Should the developer expect to move forward on the project immediately after land acquisition, he may negotiate a loan for the cost of constructing improvements, providing equity requirements from one or a combination of the sources just described. 3) TRUE A developer can obtain a permanent loan or “take out” commitment prior to construction. Funds from this permanent loan would be used to repay the ADL or construction lender when construction has been completed and lease up is completed. 4) TRUE A final note regarding the draw schedule has to do with lenders’ use of holdbacks. Generally, when project developers contract with various building contractors to perform work, developers hold back a percentage (10%) of each progress payment made to such contractors until all work is satisfactorily completed. Holding back payments assures developer control that all work has been completed in accordance with plans and specifications. 5) TRUE Version 1

When evaluating the demand for retail space, the characteristics of the tenant's demand in a given market should be considered. 6) FALSE Insurance companies and pension funds do not lend money for construction loans. 7) FALSE Construction loans involve loan draws are made for developers to pay for construction costs as needed during the construction period. 8) TRUE Construction financing typically depends on meeting contingencies including commitments for permanent financing. 9) TRUE One of the typical commitments in permanent financing is allowing the lender the authority to approve major leases on the financed property. 10) FALSE In many cases, lenders will not fund total land acquisition costs nor base loans as a percentage of appraised value. In other words, lenders prefer to make loans to cover improvement costs, and the developer may be expected to contribute the land as equity. 11) FALSE A common contingency for permanent financing is the permanent lender approval of all project design changes. 12) TRUE As the quality and number of improvements to a property increase, generally the costs also increase. 13) FALSE

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The development lender may have to depend on the developer to find a source of funds from the sale of the project, or refinancing with a permanent loan at that point in the future. In these cases, ADLs are referred to as being “uncovered,” or speculative development loans. 14) TRUE The permanent take-out commitment is expected to be used by the developer, whereas the standby commitment is typically not used by the developer. 15) B The intent of the permanent take-out commitment, then, is to create a legally binding agreement between the developer and permanent lender, whereby the permanent lender fully intends to make a long-term loan on the property after the building is completed and satisfactory levels of leasing have been accomplished. 16) A Because costs are easily observed whereas income requires estimation, the cost approach is generally preferred due to its relative conservatism. 17) C The returns are as follows: 200-unit project = $1,960,200/$22,000,000 = 0.0891, or 8.91% and 300-unit project = $2,138,400/$22,800,000 = 0.0938, or 9.38%. The 300-unit project surpasses the 9 percent required return but the 200-unit project does not. 18) B The typical process involves the following sequential phases: land acquisition, construction on the land, project completion, development management, developed site sale. 19) A

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Soft costs include architect fees, leasing costs, site planning costs and project management. 20) A Lenders typically do not include contingencies regarding hiring, as this would be an operating decision that would be time-intensive and likely unnecessary to monitor. 21) D 22) C The most commonly used method to disburse funds for commercial development is the monthly draw method. This method is used extensively in the construction of larger-scale projects requiring sizable loans. The developer requests a draw each month based on the work completed during the preceding month. 23) B Due to the higher risk to the lender of construction loans, the lender typically requires a higher interest rate and will often require that the rate vary with the market rates and inflation, in order to further limit the lender’s risk. 24) D Construction loans are analogous to a negative amortization loan with the loan balance increasing by the amount of interest accrued each month. 25) A Prior tax returns are typically not required. Most of the analysis that the interim and permanent lenders conduct focuses on the pro forma statements and market data supplied with the loan requests. This is because lenders are concerned about market conditions, rents, and the ability of the project to cover expenses and debt service. Version 1

26) B With percentage rent, developers and tenants may negotiate percentage rent in lease agreements when tenants are willing to trade off paying lower initial rents to developers in exchange for giving developers a percentage of their future sales revenues. These rents are calculated as a percentage of the sales of a tenant in excess of a predetermined breakpoint sales volume. As long as the tenant’s sales are below the breakpoint, the owner receives only the minimum rent. When a tenant’s sales increase above the breakpoint, the percentage rent rate is applied to the sales volume in excess of the breakpoint. 27) D Sometimes developers agree to manage projects even after the property has been sold. All of these situations represent reasons why it may be beneficial for the developer to contract to continue managing a property. 28) A The developer would not typically profit from leasing back a property, as they would typically choose to hold the property if they wished to continue use of the property. 29) A Due to the higher risk with construction loans, lenders typically require higher rates for these loans versus rates demanded for permanent loans. 30) D Lenders typically do not manage lower-level details such as the cleanliness of the work area. 31) C A gap loan covers the time between when funds are received through the permanent loan and when the construction loan is required to be paid.

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32) B Generally, when project developers contract with various building contractors to perform work, developers hold back a percentage (10%) of each progress payment made to such contractors until all work is satisfactorily completed. 33) B ADL lenders may require this because they realize that too much speculative, open-ended construction lending in a local market may result in significant overbuilding and an excess supply of space, which in turn, may result in more vacancies and a reduction in rents. 34) C The loan amount is generally based on the lenders analysis of (1) the appraised value expected upon completion; (2) the hard costs of construction (such as materials and labor for site improvements); and (3) soft costs, such as architect fees, leasing costs, site planning costs, and project management. 35) A Feasibility analysis is a determination of whether a project is commercially feasible at prevailing market rents, land prices, and construction and financing costs.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Option contracts are used to reserve a parcel of land so that it will not be sold to someone else while the developer does preliminary analysis of the site. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Option Contracts Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

2) Lenders typically insist on a loan repayment rate that is equal to the rate for which parcels are expected to sell. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Land Development Process Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

The release price is the dollar amount of a loan that must be repaid when a lot is sold. ⊚ true ⊚ false

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4) A feasibility study analyzes whether a tract of land can be purchased and developed profitably.

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⊚ ⊚

true false

Question Details Difficulty : 1 Easy Topic : Project Feasibility Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

5) An option contract does not preclude the landowner from selling the property to someone else after the expiration date of the option. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Option Contracts Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

The release schedule refers to a schedule of expiring leases for existing tenants. ⊚ true ⊚ false

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7) By using an option contract, a developer may profit from an appreciation in the property’s value over the option period. ⊚ true ⊚ false

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8) In most instances, a developer's repayment rate is set so that the development loan will be repaid at the exact point that 100 percent of total project revenue is realized. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Lender Requirements Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

9) It is proper to include an estimate for developer profit as a cost of development when projecting net cash flows and evaluating whether a required rate of return will be met. ⊚ true ⊚ false Question Details Topic : Lender Requirements Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

10) A lender does not usually require a developer to submit a schedule of estimated cash flows prior to approving a land development loan. ⊚ true ⊚ false

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11) A developer must sell all lots in a development project and repay the entire development loan before any of the new property owners can receive a clear title. ⊚ true ⊚ false Question Details Topic : Land Development Process Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

12) In order to obtain a land development loan, the developer is usually required to purchase title insurance. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Lender Requirements Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

13) It is common for a developer to hold back funds before making final payment to ensure that subcontractors perform all work completely. ⊚ true ⊚ false

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Question Details Difficulty : 1 Easy Topic : Land Development Process Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

14)

It is illegal for the lender to hold back funds from the developer. ⊚ true ⊚ false

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15) The loan submission package for a land development project must include project information, market financial data, government and regulatory information, legal documentation, and emergency contingency plans. ⊚ true ⊚ false Question Details Topic : Lender Requirements Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

16) While permitted for building projects, holdbacks are not permitted for land development projects. ⊚ true ⊚ false

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 17) Consider the feasibility study shown in the table. What is the return on total cost for the proposed project? Total sales revenue Less: Development cost Less: Land asking price Potential gross profit Less: Administration, legal, commissions, etc.

$ 10,000,000 6,000,000 1,000,000 $ 3,000,000 1,500,000

Potential net profit

$ 1,500,000

A) 15.0% B) 17.6% C) 21.4% D) 150.0%

Question Details Topic : Project Feasibility Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

18) Consider the feasibility study shown in the table. You have been advised that sales revenues may be 10 percent lower and/or development costs may be 10 percent higher. Performing a sensitivity analysis, you conclude which of the following? Total sales revenue

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$ 10,000,000

Less: Development cost Less: Land asking price Potential gross profit Less: Administration, legal, commissions, etc.

6,000,000 1,000,000 $ 3,000,000 1,500,000

Potential net profit

$ 1,500,000

A) A 10 percent decrease in sales revenues would have a bigger impact on returns than a 10 percent increase in development costs. B) A 10 percent increase in development costs would have a bigger impact on returns than a 10 percent decrease in sales revenues. C) A 10 percent increase in development costs and a 10 percent decrease in sales revenues would have opposite impacts on returns, canceling each other out and having no impact on returns. D) Both factors would have such a small impact that there is no reason to be concerned about either a 10 percent increase in development costs or a 10 percent decrease in sales revenues.

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19) Consider the table, which summarizes monthly construction draws and sales revenues. What is the percentage of lot sales revenue that needs to be used to repay the loan? Month 1

Construction Draw $ 200,000

150,000

75,000

4 Total Present value @ 12%

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25,000 $ 450,000 $ 441,883

Sales Revenue

$ 600,000 $ 600,000 $ 576,588

A) 4.0% B) 75.0% C) 76.6% D) 33.3%

Question Details Difficulty : 2 Medium Topic : Repayment Rates Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

20) The land development industry is best characterized by which of the following statements? A) The land development industry is dominated by relatively few national competitors. B) The land development industry is highly fragmented, localized, and extremely competitive. C) Land development and project development are synonymous. D) The production technologies and market risks involved in land development are essentially the same as those in project development.

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21) Which of the following is the MOST LIKELY sequence of events in the land development process?

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A) Inspect site, perform feasibility analysis, implement marketing program, purchase land and begin construction of improvements B) Inspect site, purchase land and begin construction of improvements, perform feasibility analysis, implement marketing program C) Inspect site, perform feasibility analysis, purchase land and begin construction of improvements, implement marketing program D) Purchase land, perform feasibility analysis, perform preliminary market study, begin construction of improvements, implement marketing program

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22)

Generally, which of the following is FALSE regarding an option contract?

A) An option contract allows the developer to perform a preliminary market study and feasibility analysis. B) If the developer decides to purchase a property, the price of an option is applied towards the price of the property. C) If the developer decides not to purchase the property, the landowner will refund any money paid for the option. D) An option contract provides the developer with the assurance that a property will not be sold over the course of the option period.

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23) Each parcel of land in a new development is selling for $15,000 and the total project revenue is estimated to be $5,000,000. The project lender has stated that the loan should be paid off when 80 percent of the total project revenue has been earned. The total loan amount is $3,500,000. What is the release price for each parcel? A) $8,400 B) $12,000 C) $12,750 D) $13,125

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24) Which of the following might impact the density of housing in a land development project? A) The price paid for the land by the developer B) The terrain of the land C) The target market’s preferences regarding density D) All of the choices are correct

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25) Which of the following costs should NOT be included in a net present value analysis of a land development project?

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A) Land purchase price B) Property tax C) General overhead such as personnel costs D) Developer’s profit

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26) When financing land development, the lender generally requires the developer to submit which of the following? A) A detailed breakdown of project cost B) Required zoning changes C) Bank references for the general contractor to be used on the project D) All of the choices are correct

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27) A transaction in which two firms trade individual financing advantages to produce more favorable borrowing terms for each is known as a(n): A) interest rate swap. B) sequential short hedge. C) cross hedge. D) sequential long hedge.

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28) Generally, which of the following is FALSE regarding interest rate risk management techniques? A) Borrowers can protect themselves from upward movements in interest rates by using interest rate caps. B) Borrowers can protect themselves from upward movements in interest rates by using interest rate futures contracts. C) Borrowers can benefit from downward movements in interest rates by using interest rate caps. D) Borrowers can benefit from downward movements in interest rates by using interest rate futures contracts.

Question Details Topic : Land Development Process Difficulty : 3 Hard Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 3 Apply Accessibility : Screen Reader Compatible

29)

An analysis of whether land can be purchased and developed profitably is known as: A) financial analysis. B) a feasibility study. C) a turnkey study. D) project profitability analysis.

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Question Details Difficulty : 1 Easy Topic : Project Feasibility Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

30)

The amount to be paid to the lender from each lot sale is included in the: A) release schedule. B) development agreement. C) cost breakdowns. D) subcontracts.

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31) Which of the following does NOT contribute to the complication of estimating the amount of interest carry? A) The loan is taken down in draws and interest is calculated only as funds are drawn down. B) Revenue from each type of site varies. C) The rate of repayment of a loan depends on when the parcels are actually sold. D) Development loan interest rates are usually fixed while market rates fluctuate.

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32)

Which of the following is FALSE regarding the release price? A) It is usually calculated to pay off the loan when the last lot is sold. B) It is usually calculated to pay off the loan before the last lot is sold. C) Increasing the release price usually lowers the lender’s risk. D) Increasing the release price is likely to lower the investor’s initial cash flow.

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33) If a developer constructs some speculative buildings in hopes of identifying purchasers after completion, this is referred to as developing: A) in a feasibility construction. B) on a turnkey basis. C) on a build-to-suit basis. D) in optional construction.

Question Details Topic : Land Development Process Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

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34) Since land development projects sometimes run behind schedule due to development problems or slow sales of parcels, lenders generally require which of the following in the initial contract? A) Subcontractor holdbacks B) Title extensions C) Extension agreements D) Releases from liability

Question Details Difficulty : 1 Easy Topic : Lender Requirements Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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Answer Key Test name: Ch17 1) TRUE The developer usually negotiates an option contract because it takes time to accomplish various tasks and activities prior to the decision to actually purchase the land. 2) FALSE As a parcel is sold, the lender will receive a partial repayment of the loan that corresponds to the revenue produced from each sale. 3) TRUE The amount that the borrower pays the lender to obtain this release is referred to as the release price. 4) TRUE The goal of a feasibility study is to provide a preliminary development plan and financial analysis to determine whether a large-scale residential lot development can be built in accordance with regulatory requirements and sold at market prices sufficiently high enough to justify construction costs and the cost of land acquisition. 5) TRUE The option contract ends at expiration. 6) FALSE Developers and lenders usually negotiate amounts to be paid for each type of developed site in a project, which is referred to as a release schedule. 7) TRUE Version 1

When the land appreciates in value during the option contract period, the developer typically is able to realize this appreciation as profit. 8) FALSE The lender will not want to wait until the last lot is sold to have the loan completely repaid. The lender does not want to incur the risk that a slowdown in lot sales or difficulty selling some of the lots will significantly delay loan repayment. Thus, the actual release price negotiated with the lender will normally be higher than the release prices shown above. 9) FALSE Developer profit should not be included when determining projected net cash flows and evaluating the ability to meet a required rate of return. 10) FALSE Estimated cash flows are a main requirement by most lenders. 11) FALSE When a developer sells a parcel and repays a lender or lenders, the developer obtains a release statement in which lenders waive all liens on the parcel to be sold. Clear title may then pass from the developer to the buyer of the parcel. Sale of all lots is not required. 12) TRUE Title insurance is a typical requirement by most lenders. 13) TRUE Holding back funds is a common practice that helps developers to ensure all subcontractor work is performed according to agreements. 14) FALSE

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The lender may hold back from the developer so that no excess funds are made available to the developer during the period the developer is holding back from subcontractors. 15) FALSE Emergency contingency plans are not required. 16) FALSE Land development loans may also provide for a holdback of a proportion of each disbursement payable to a developer. 17) B $1,500,000 /$8,500,000 sales revenue = 0.176, or 17.6% net profit 18) A A 10 percent decrease in revenue would result in a $1,000,000 decrease in profit, whereas a 10 percent decrease in development costs would only result in a $600,000 decrease in profit. 19) C $441,883/$576,588 = 0.766, or 76.6% 20) B An observation about land development is that the industry is highly fragmented, localized, and competitive. Many land development firms usually exist in any given urban market. 21) C The typical events in chronological order are: inspect site, perform feasibility analysis, purchase land and begin construction of improvements, implement marketing program 22) C The amount paid for the option is not refunded if it is not exercised.

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23) D Total Revenue $ 5,000,000 80%

$/parcel $ 15,000

$ 4,000,000 $ 3,500,000

# of parcels 333.33

266.67 $ 13,125

24) D All of these factors have impacts on the density of housing in a development project and should be considered by the developer. 25) D The developer’s profit should not be considered in determining the net present value of a potential project. 26) D All of these elements are typically required by the lender prior to committing to a loan to a developer. 27) A An interest rate swap is a transaction in which two firms trade individual financing advantages to produce better borrowing terms. 28) D Borrowers can protect themselves from upward movements in interest rates by using interest rate futures contracts. 29) B A feasibility study provides a preliminary development plan and financial analysis to determine whether a large-scale residential lot development can be built in accordance with regulatory requirements and sold at market prices sufficiently high enough to justify construction costs and the cost of land acquisition.

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30) A Developers and lenders usually negotiate amounts to be paid for each type of developed site in a project, which is referred to as a release schedule. 31) D Development loan interest rates are typically made on a floating rate basis. 32) A The lender will not want to wait until the last lot is sold to have the loan completely repaid. The lender does not want to incur the risk that a slowdown in lot sales or difficulty selling some of the lots will significantly delay loan repayment. Thus, the actual release price negotiated with the lender will normally be higher than the release prices shown above. 33) B In some cases, the developer may construct a building on a site on a speculative basis hoping to find tenant/buyer willing to purchase the project on a turnkey basis. 34) C Because it is possible that the loan will not be paid on time due to development problems or the slow sale of parcels, the lender usually requires an extension agreement clause in the initial loan contract. This clause specifies that an additional charge will be made for any extra time needed to repay the loan.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) An IRR preference will always give the investor a return that is equal to or better than what the return would be with an IRR lookback. ⊚ true ⊚ false Question Details Topic : Cash Flows Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

2) A disadvantage of a limited partnership is that any tax losses can be allocated to the partners to reduce their personal taxable income. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Forms of Ownership Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

3) A general partner is personally liable for the debts of the partnership whereas a limited partner has "limited liability" like shareholders in a corporation. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Forms of Ownership Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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4) C-corporations have the advantage of providing a pass-through of income for tax purposes. ⊚ true ⊚ false Question Details Topic : Forms of Ownership Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

5) Syndications can take the form of corporations, limited partnership, or other organizational forms. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Syndications Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

6) When a syndication is offered as a "blind pool" offering, the properties to be purchased are not identified before funds are raised. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Syndications Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

7) A limited partnership limits the general partners’ liability to the capital they originally invested.

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⊚ ⊚

true false

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8) Capital accounts are debited for cash contributed to the partnership and credited for cash distributed to the partner. ⊚ true ⊚ false Question Details Topic : Cash Flows Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

9) According to IRS rules, interest and real estate taxes incurred during construction of real property improvements must be included in the depreciable basis of the property. ⊚ true ⊚ false Question Details Topic : Cash Flows Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

10) Deductions for payment to a developer or syndicator for their covenants not to compete with a specific project are never allowed according to IRS rules. ⊚ true ⊚ false

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11) Joint ventures typically involve many individual investors joining together to purchase real estate. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Forms of Ownership Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

12)

Tax losses cannot be allocated to partners in a syndication. ⊚ true ⊚ false

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13) If a developer does not have sufficient cash flows to provide an investor-partner with a preferred distribution, the requirement to do so carries over to the following year. ⊚ true ⊚ false

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MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 14) Which of the following statements is TRUE regarding general partnerships? A) They usually are suggested for groups of individuals that are seeking to form a business entity to invest in real estate because of the unlimited liability of each partner. B) They usually are not suggested for groups of individuals that are seeking to form a business entity to invest in real estate because of the unlimited liability of each partner. C) They protect each of the partners from potential losses associated with the partnership's business activities. D) They have assessed income taxes at a lower rate than corporations.

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15)

Noncumulative pari passu distribution refers to:

A) the payment of dividends by S-corporations. B) a payment received by money partners and operating partners in proportion to their capital investment. C) payments distributed when the enterprise has negative cash flows. D) the difference in payments received by partners and the payments received by bondholders.

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16) A partnership agreement provides that, at sale, cash proceeds are distributed first to Mr. Smith in an amount equal to his original investment less any cash distributions previously received, then split 50-50 between Mr. Smith and Ms. Jones. Assume that the cash flows from sale are $1 million. How much would Mr. Smith receive if his initial investment was $400,000 and he previously received $25,000 in distributions? A) $312,500 B) $375,000 C) $487,500 D) $687,500

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17)

Which of the following BEST defines the term "real estate syndication?"

A) A group of investors who have combined their financial resources with the expertise of a real estate professional to carry out a real estate project. B) An organization that acts as a single legal entity and is held separate from the individual investors. C) An organizational form of real estate ownership in which income and expenses are passed through to individuals. D) A group of investors who have combined their financial resources to provide debt funding for a real estate project.

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18) Tom invested $20,000 in a limited partnership. His share of liabilities from mortgage debt was initially $45,000. The property suffered a loss in income during the first year, of which Tom's share was $5,000. However, in Years 2 through 4 income allocated from the account equaled a total of $9,000 ($3,000 per year). The allocated reduction in debt at the end of Year 4 from amortization of the loan is equal to $1,100. What is Tom's basis in the partnership interest at the end of Year 4? A) $67,900 B) −$9,900 C) $77,900 D) $70,100

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19) Tom invested $20,000 in a limited partnership. His share of liabilities from mortgage debt was initially $45,000. The property suffered a loss in income during the first year, of which Tom's share was $5,000. However, in Years 2 through 4 income allocated from the account equaled a total of $9,000 ($3,000 per year). The allocated reduction in debt at the end of Year 4 from amortization of the loan is equal to $1,100. What is the balance of Tom's capital account at the end of Year 4?

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A) −$9,900 B) $24,000 C) $69,000 D) $70,100

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20) In a syndication, when cash is distributed from an investor's partnership basis, how is the new basis calculated? A) The cash distribution is added to the investor’s capital gain. B) The cash distribution is subtracted from the investor’s capital gain. C) The cash distribution is added to the investor’s partnership basis. D) The cash distribution is subtracted from the investor’s partnership basis.

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21) Which of the following does NOT need to occur for a partnership allocation to have substantial economic effect?

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A) An adjustment must be made in the partner’s capital account B) Liquidation proceeds must be distributed in accordance with capital accounts C) Profits and losses must be allocated to different partners in proportion to their equity contribution D) Following the distribution of sale proceeds, partners must be liable to the partnership to restore any deficit in their capital accounts

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22) as:

Sharing cash flow in a joint venture in proportion to the capital contribution is referred to

A) pari passu. B) equal sharing. C) preferred return. D) equity sharing.

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23) When one investor receives cash flow to achieve a certain IRR before splitting the remaining cash flow it is referred to as:

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A) IRR lookback. B) IRR preference. C) preferred IRR. D) adjusted IRR.

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24) How should interest prepayments (including points) for income-producing real estate be handled for tax purposes? A) They should be expensed over the first year. B) They should be amortized over a period of no less than 60 months. C) They should be amortized over the life of the loan. D) They should be capitalized and deducted once the loan is paid off.

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25) A syndicate that raises capital before identifying any or all of the properties it will eventually own is known as a(n): A) Safe harbor. B) Accredited investor. C) Caveat. D) Blind pool.

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26) Interest and real estate tax incurred during construction of real property improvements must be: A) deducted from the resale price of the property. B) included in the depreciable basis of the property. C) expensed over the construction period. D) excluded from the value of improvements.

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27) Which of the following imposes certain ownership and minimum capital requirements to avoid "dummy" corporations acting as sole corporate general partners? A) Safe harbor rules B) Caveat rules C) Blind pool rules D) Corporate regulations

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28) Which of the following is NOT one of the criteria used to determine whether a partnership will be treated as a corporation for tax purposes? A) Unlimited liability B) Continuity of life C) Centralization of management D) Free transferability of interests

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29) Which form of ownership may be viewed unfavorably for use in real estate investment due to the personal liability associated with this approach? A) General partnership B) Limited partnership C) Sole proprietorship D) C corp

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30) Which of the following legal entities will likely be ended once the objectives of the effort have been met? A) Limited partnership B) S corp C) Limited liability corporation D) Joint venture

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31) An arrangement in which a developer/operator may receive a substantial incentive after initial distributions have been made is referred to as a: A) bonus. B) promote. C) cumulative distribution. D) consideration.

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Answer Key Test name: Ch18 1) TRUE In an IRR preference, one or more investors must receive cash flow that is sufficiently high to achieve a specified IRR on equity invested for the entire investment period before others share in cash flows from sale. A slight variation of the IRR preference distribution is referred to as an IRR lookback. In a lookback, any cash flow remaining after the parties have each received capital equal to their initial investment will be split in a predetermined proportion, such as 50 percent to each party. However, this split may be subject to the condition that one or more partners must earn a specified IRR. If this is not achieved in the 50 percent split, then some of the cash that would have gone to all partners must be distributed so that partners who must earn an IRR lookback do so. 2) FALSE The Tax Reform Act of 1986 removed many of the tax advantages associated with the use of limited partnerships relative to other forms of real estate ownership. For example, any tax losses resulting from investments in limited partnerships are subject to the passive activity limitation rules. 3) TRUE This represents the key difference between the general and limited liability forms of partnership. 4) FALSE A general partnership is a pass-through tax entity but a C-corporation is not. Version 1

5) TRUE Syndications can be structured under many forms including, among others, corporations and limited partnerships. 6) TRUE A syndicator may desire to raise a large amount of funds to acquire many properties. The particular properties to be acquired may or may not be identified when the funds are raised. If not, the offering is referred to as a blind pool. 7) FALSE In a limited partnership, limited partners, like shareholders in a corporation, are only liable for the money they have at risk, and they bear no legal liability for the actions of general partners. 8) FALSE Capital accounts are maintained by crediting the account for all cash contributed to the partnership and all income and gain allocated to each partner. The account is then debited for cash distributed to the partner plus any loss allocated to the partner. 9) TRUE The IRS requires that interest and real estate taxes incurred during construction be included in the depreciable basis. 10) FALSE The IRS may allow deductions for payment to a developer or syndicator for non-compete covenants. 11) FALSE Two is the minimum number of parties required to form a joint venture. 12) FALSE

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The IRS permit a certain level of tax losses to be allocated to partners in a syndication. 13) TRUE This preferred distribution may be carried forward to years in which the cash flows are sufficient to pay out the distribution. 14) B The unlimited liability is one of the key disadvantages to a general partnership. 15) B One way to share cash flow from operating a property (NOI less debt service) is in proportion to the capital investment. For instance, if the developer contributes 10 percent of required equity, he will receive 10 percent of the cash flow. This is referred to as noncumulative pari passu distribution of the cash flows. 16) D $ 400,000 $ 25,000 $ 375,000 $ 1,000,000 $ 375,000 $ 625,000 50% $ 312,500 $ 687,500

17) A The concept of real estate syndication extends generally to any group of investors who have combined their financial resources with the expertise of a real estate professional for the common purpose of carrying out a real estate project. A syndication is not an organization form per se. It may take any of the legal business forms such as a corporation, limited partnership, or general partnership. Version 1

18) A $ 20000 $ 45000 $ 65000 $ 5000 $ 60000 $ 9000 $ 69000 $ 1100 $ 67900

19) B $20,000 − $5,000 + $9,000 = $24,000 20) D When cash distributions occur, the distribution is subtracted from the investor's partnership basis to determine the new basis. 21) C One of the advantages of a partnership, whether a limited partnership or a general partnership between a few individuals, is the ability to allocate profit and loss to different partners in different proportions than their equity contribution. 22) A One way to share cash flow from operating a property (NOI less debt service) is in proportion to the capital investment. For instance, if the developer contributes 10 percent of required equity, he will receive 10 percent of the cash flow. This is referred to as noncumulative pari passu distribution of the cash flows. 23) B With an IRR preference, one or more investors must receive cash flow that is sufficiently high to achieve a specified IRR on equity invested for the entire investment period before others share in cash flows from sale.

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24) C For income-producing properties, interest payments, including any applicable points, should be amortized over the life of the loan. 25) D A syndicator may desire to raise a large amount of funds to acquire many properties. The particular properties to be acquired may or may not be identified when the funds are raised. If not, the offering is referred to as a blind pool. 26) B The IRS requires that interest and real estate tax incurred during construction of property improvements be included in the depreciable property basis. 27) A To avoid dummy corporations as the sole corporate general partner, the Internal Revenue Service follows internal guidelines (called safe harbor rules) that impose certain ownership and minimum capital requirements. 28) A A corporation has the key benefit of limited liability. 29) C Sole proprietorships result in unlimited personal liability, so these are typically not the best approach for real estate investing. 30) D Joint ventures are formed by at least two parties with the intent of achieving a spe-cific investment objective. Unlike many other business agreements, when the objective is achieved, the joint venture (JV) is usually terminated. 31) B Version 1

With a promote, the developer may receive a significant incentive after the initial distributions have been made. For example, the developer/operators may have invested only 5 percent of the capital but will receive an incentive of 50 percent of cash flow remaining after the initial distributions.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) In 2008, Fannie Mae was spun off in an initial public offering as a private company. ⊚ true ⊚ false Question Details Topic : Secondary Mortgage Market Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

2) The secondary mortgage market enables mortgage banking companies to sell existing mortgages and thereby replenish funds with which new loans can be originated. ⊚ true ⊚ false Question Details Topic : Secondary Mortgage Market Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

3) One difference between mortgage securities and corporate bonds is that mortgage securities tend to be "overcollateralized." ⊚ true ⊚ false Question Details Topic : Secondary Mortgage Market Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

4) An optional delivery commitment gives Fannie Mae the right (but not the obligation) to purchase mortgage loans from originators.

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⊚ ⊚

true false

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5) Under the HUD Act of 1968, assets, liabilities, and management of secondary market operations were transferred to a completely private corporation known as "Ginnie Mae" (GNMA). ⊚ true ⊚ false Question Details Topic : Secondary Mortgage Market Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

6) The Federal Home Loan Mortgage Corporation’s primary purpose is to provide liquidity for conventional mortgage originators just as FNMA and GNMA did for originators of FHA-VA mortgages. ⊚ true ⊚ false Question Details Topic : Secondary Mortgage Market Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

7) When issuing mortgage-backed bonds, the issuer transfers ownership of the underlying mortgage to the investors/bondholders.

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⊚ ⊚

true false

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8) When market interest rates exceed the coupon rate of an MBB, the price of the bond will be greater than its par value. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : MBBs Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

9) Marking the mortgage to market is the process of accumulating mortgage pools and marketing them to individual investors as mortgage-backed bonds. ⊚ true ⊚ false Question Details Difficulty : 3 Hard Topic : MBBs Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 3 Apply Accessibility : Screen Reader Compatible

10) A mortgage pass-through security represents an undivided ownership interest in a pool of mortgages held by a trustee. ⊚ true ⊚ false

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11) When a pass-through security investor makes repetitive requests of a mortgagor, it is referred to as a nuisance call. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : MPTs Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

12) Generally, prices for zero coupon mortgage-backed bonds are more sensitive to interest rate changes than interest bearing MBBs. ⊚ true ⊚ false Question Details Topic : MBBs Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

13) The standard PSA prepayment curve assumes prepayments of 0.2 percent per month for the first 12 months, and then increases by 0.2 percent per month until month 30. ⊚ true ⊚ false

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14) Issuers typically pledge 105 percent to 120 percent in mortgage collateral in excess of par value of the securities issued, in order to overcollateralize MBBs. ⊚ true ⊚ false Question Details Topic : MBBs Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 15) Which of the following is NOT a major type of mortgage-related security? A) Mortgage-backed bonds (MBBs) B) Mortgage pass-through security (MPTs) C) American depositary receipts (ADRs) D) Collateralized mortgage obligations (CMOs)

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16) A rising rate of market interest would have which of the following impacts on a mortgage pass-through security? A) Increase the market value of the MPT B) Decrease the market value of the MPT C) Increase or decrease, depending on whether the MPT was issued at a premium or a discount D) The market rate of interest has no impact on the market value of an MPT

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17) A falling rate of market interest would have which of the following impacts on a mortgage pass-through security? A) Increase prepayments on loans in the pool B) Decrease prepayments on loans in the pool C) Decrease the market value of the MPT D) Both "Increase prepayments on loans in the pool" and "Decrease the market value of the MPT"

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18) A 25-year maturity mortgage-backed bond is issued. The bond has a par value of $10,000 and promises to pay an 8 percent annual coupon. At issue, bond market investors require a 12 percent interest rate on the bond. What is the initial price on the bond?

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A) $588 B) $5,686 C) $6,863 D) $14,270

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19) A 25-year maturity mortgage-backed bond is issued. The bond has a par value of $10,000 and promises to pay an 8 percent annual coupon. At issue, bond market investors require a 12 percent interest rate on the bond. Assume that 20 years after the bond is issued, bond market investors require a 15 percent interest rate on the bond. What is the market price of the bond after 20 years? A) $5,686 B) $6,863 C) $7,653 D) $14,270

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20) A 10-year maturity mortgage-backed bond is issued. The bond is a zero coupon bond that promises to pay $10,000 (par) after 10 years. At issue, bond market investors require a 15 percent interest rate on the bond. What is the initial price on the bond?

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A) $2,252 B) $2,472 C) $8,696 D) $10,000

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21) Which of the following developments assure mortgage investors they will receive interest and principal payments at little or no risk? A) The availability of hazard and title insurance. B) The availability of mortgage default insurance and loan guarantees. C) The development of standardized loan underwriting, processing, and servicing. D) All of the choices are correct.

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22) The Government National Mortgage Association (GNMA) was organized to perform three principle functions. Which of the following is NOT a function of GNMA?

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A) Provide special assistance lending in support of federal programs. B) Manage and liquidate mortgages previously acquired by FNMA. C) Manage all secondary mortgage market operations. D) Provide a guarantee for FHA/VA mortgage pools that would provide a guarantee for mortgage backed securities.

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23)

Which of the following statements regarding mortgage-backed bonds is generally TRUE?

A) The total value of the MBBs issued usually equals the value of the mortgages in the underlying pool. B) Unlike corporate bonds, MBBs usually are issued with variable coupon rates of interest. C) Overcollateralization of the mortgage pool assures investors that the income from the mortgage will be sufficient to pay the interest on the bonds and the principal upon maturity. D) All of the choices are true.

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24) When evaluating an investment in a mortgage pass-through security, which of the following is NOT one of the characteristics of the underlying mortgage pool that should be considered?

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A) The amount of overcollateralization of the mortgage pool. B) The geographic distribution of the mortgages. C) The amount of seasoned mortgages included in the pool. D) All of the choices should be considered.

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25) When pricing mortgage pass-through securities, issuers use each of the following methods to include prepayment assumptions EXCEPT: A) FHA prepayment experience. B) the pool factor technique. C) the PSA prepayment model. D) constant rates of prepayment.

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26)

Prices of mortgage pass-through securities are:

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A) unaffected by changes in interest rates. B) related positively to changes in interest rates. C) more sensitive to declines in interest rates and less sensitive to increases in interest rates. D) less sensitive to declines in interest rates and more sensitive to increases in interest rates.

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27) Compared to mortgage pass-though securities (MPTs), MBBs should be priced to provide: A) lower yields, because the MBB issuer bears lower prepayment risk. B) higher yields, because the MBB issuer bears higher prepayment risks. C) the same yields, because of equivalent amounts of prepayment risk. D) None of the choices are correct.

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28) If a mortgage pool consists of five 10 percent FRMs totaling $500,000, five 9 percent FRMs totaling $450,000, and ten 8 percent FRMs totaling $750,000, what is the weighted average coupon rate?

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A) 8.75% B) 8.85% C) 9.00% D) None of the choices are correct.

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29) The pass-through rate is the coupon rate of interest promised by the issuer of a passthrough security to the investor. In most instances, the pass-through rate is: A) equal to the average rate of interest on all mortgages in the underlying pool. B) lower than the lowest rate of interest on any mortgage in the underlying mortgage pool. C) higher than the highest rate of interest on any mortgage in the underlying mortgage pool. D) not described by any of the choices.

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30)

All other conditions being the same, the more seasoned a mortgage is:

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A) the greater the likelihood of prepayment. B) the greater the likelihood of default. C) the greater the likelihood that the mortgage will be carried to maturity. D) All of the choices are correct.

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31)

Which of the following is NOT a guarantee of Ginnie Mae (GNMA)? A) Timely payments of principal and interest B) Settling accounts with servicer C) Payment of all mortgages at maturity D) Repayment of outstanding loan balances upon default

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32)

The primary purpose of Freddie Mac (FHLMC) is to: A) provide a secondary market for mortgage originators. B) provide investors with a guaranteed rate of return. C) create competition for Fannie Mae and Ginnie Mae. D) provide consumers with more options when deciding on a mortgage loan.

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33)

Which of the following is FALSE regarding mortgage-backed bonds (MBBs)? A) Their issuer retains ownership of mortgages B) Their maturity is indefinite at issuance C) They are issued with fixed coupon rates D) They are usually underwritten by investment banking companies

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34) The investment rating for mortgage-backed bonds depends on each of the following EXCEPT: A) appraised value and DCR. B) interest rates in mortgage pool. C) extent of over collateralization. D) initial price paid for the security.

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35)

Which of the following is NOT a risk for mortgage-backed securities? A) Default risk B) Delayed payment risk C) Pass-through risk D) Interest rate risk

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36) The practice that is implemented with MBBs to compensate for the likelihood that some borrowers will default or make delayed payments on mortgage loans that make up the pool is: A) default compensation. B) tardy payment compensation. C) prompt payment actions. D) overcollateralization.

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37) The process that a trustee would use in assessing whether the value of a mortgage pool is within the required overcollateralization levels is referred to as:

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A) the overcollateralization process. B) marking to market. C) MBB appraisal. D) market value assessment.

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Answer Key Test name: Ch19 1) FALSE In 2008, due to concerns about FNMA’s viability in light of the subprime mortgage crisis, the Federal Housing Finance Agency (FHFA) was appointed as conservator of FNMA, thus placing FNMA under federal government control. 2) TRUE This is the main objective of the secondary mortgage market. 3) TRUE Mortgage securities tend to be overcollateralized. Overcollateralization ensures that interest payments promised to security holders will continue even though some mortgages may be in default. 4) FALSE The optional delivery commitment program gives the mortgage originator the “right but not the obligation” to sell the mortgages to Fannie Mae. 5) FALSE In 1968, Ginnie Mae initiated the mortgage-backed guarantee program. This program represented an attempt to create a mortgage-backed investment capable of competing with corporate and government securities for investment funds. 6) TRUE

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The Federal Home Loan Mortgage Corporation (FHLMC), more commonly known as Freddie Mac, has the primary purpose to provide a secondary market and, hence, liquidity for conventional mortgage originators just as Fannie Mae and Ginnie Mae did for originators of FHA-VA mortgages. 7) FALSE When issuing MBBs, the issuer establishes a pool of mortgages—this pool usually includes residential mortgages, but commercial mortgages and other mortgage-related securities may also be used—and issues bonds to investors. 8) FALSE When market interest rates exceed the coupon rate of an MBB, the price of the bond will be less than its par value. 9) FALSE To make an estimate of the value of mortgages in the pool (referred to as marking the mortgages to market), the trustee must value each of the mortgages in the pool by first establishing the number and outstanding balance of each mortgage in trust. 10) TRUE Mortgage pass-through securities are issued by a mortgage originator (e.g., mortgage company, thrift) and represent an undivided ownership interest in a pool of mortgages. 11) FALSE

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Where the prepayment rate reaches the point where a diminishing number and amount of mortgages remain in the pool, say about 10 percent of the initial pool amount, the servicer may call the remainder of the securities. This call is referred to as a nuisance or cleanup call and is used when the cost of servicing begins to become large relative to servicing income. 12) TRUE The greater price sensitivity for zero coupon bonds relative to interestbearing bonds occurs because all income is deferred until maturity with the zero coupon bond. Therefore, its present value will always be more sensitive to changes in interest rates than that of investments returning some cash flows during the investment period. 13) TRUE At present, the standard PSA prepayment rate curve (referred to as 100% PSA) begins at 0.2 percent per month for the first year, and then increases by 0.2 percent each month until month 30. It then remains at 0.5 percent per month, or 6 percent per year, for the remaining stated maturity period of the pool. 14) FALSE Historically, issuers have pledged from 125 percent to 240 percent in mortgage collateral in excess of the par value of securities issued. 15) C MBBs, MPTs, and CMOs are all common forms of mortgage securities. 16) B MPTs face reductions in market value due to an unanticipated rise in interest rates. This risk is generally greatest for pools containing fixed interest rate loans.

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17) A The variation in interest rates on a mortgage pool may be very important for investors to consider. This occurs because each mortgage included in a pool with different interest rates will have a lower likelihood of prepayment than pooled mortgages with the same interest rate. This likelihood exists because mortgages with one interest rate are all more likely to be prepaid, should interest rates decline. 18) C The initial price is the present value, which is calculated as =PV(0.12,25,-0.08*10,000,-10,000) = $6,863. 19) C The price after 20 years will be the present value of the remaining payments and par value at the market interest rate, which is =PV(0.15,5,0.08*10,000,-10,000) = $7,653. 20) B The price will be the present value of the future par value, or =PV(0.15,10,,-10,000) = $2,472. 21) D Given (1) the availability of default insurance and loan guarantees, (2) the development of stan-dardized loan underwriting, processing, and servicing, and (3) the availability of hazard and title insurance, investors in mortgages could acquire a large quantity of loans and expect to receive interest and principal payments with little or no risk. 22) C

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The Government National Mortgage Association (GNMA) was organized to perform three principal functions: (1) management and liquidation of mortgages previously acquired by FNMA—the liquidation of the portfolio acquired from FNMA at the time of its partition comes through regular principal repayments and sales; (2) special-assistance lending in support of certain federal subsidized housing programs; GNMA, also known as “Ginnie Mae,” is authorized to guarantee mortgages that are originated under various housing programs designed by FHA, to provide housing in areas where it cannot be provided by conventional market lending; and (3) provision of a guarantee for FHAVA mortgage pools, which would provide a timely payment of principal and interest guarantee for mortgage-backed securities. 23) C The overcollateralization ensures that interest payments promised to security holders will continue even though some mortgages may be in default. Further, some loans may be prepaid either before the maturity date of the mortgage or before the bond maturity date. Because mortgage-backed bonds are issued for a specified number of years, overcollateralization ensures that, as mortgages are prepaid, others will still be in the pool to replace them. 24) D All of these factors are important considerations in evaluating an investment in an MPT. 25) B The average maturity, constant rates of repayment, FHA prepayment experience, and PSA prepayment model are the four broad methods that issuers use to include prepayment assumptions when pricing securities. 26) D

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Prices of mortgage pass-throughs (MPTs) are inversely related to interest rates; however, they are less sensitive to declines in interest rates and more sensitive to increases in interest rates because rates of repayment are likely to accelerate as interest rates fall and slow as interest rates rise. 27) B With MBBs, issu-ers bear prepayment risk by virtue of the overcollateralization requirement. In other words, as prepayments accelerate and mortgages are prepaid, more mortgages must be replaced in the pool. With MPTs, security holders bear prepayment risk because all prepayments are passed through to investors. This means that (1) MBBs should be priced to provide lower yields than MPTs because the MBB issuer bears prepayment risk and (2) as market interest rates change, the price of MBBs will not reflect accelerated prepayment rates. 28) B 10.0%

$ 500,000

$ 50,000

9.0%

$ 450,000

$ 40,500

8.0%

$ 750,000

$ 60,000

$ 1,700,000

$ 150,500

8.85%

29) B The coupon rate on pass-throughs is lower than the lowest rate of interest on any mort-gage in the pool. The difference between the two rates is known as the servicing fee. 30) A The more seasoned a mortgage is, the greater the like-lihood of prepayment. The likelihood that borrowers will sell houses, change job locations, and so on increases with the length of time the mortgage has been outstanding. Version 1

31) C Though the GNMA provides many guarantees that minimize the risk to investors, GNMA does not guarantee the payment of all mortgages at maturity. 32) A Federal Home Loan Mortgage Corporation (FHLMC), is more commonly known as Freddie Mac. Its primary purpose was to provide a secondary market and, hence, liquidity for conventional mortgage originators just as Fannie Mae and Ginnie Mae did for originators of FHA-VA mortgages. 33) B Like corporate bonds, MBBs are usually issued with fixed-coupon rates and specific maturities. 34) D The initial price paid for the security is not a factor that impacts the investment rating for an MBB. 35) C Pass-through risk is not a risk of MBBs. Mortgage pass-through securities (MPTs) are issued by a mortgage originator (e.g., mortgage company, thrift) and represent an undivided ownership interest in a pool of mortgages. 36) D Mortgage securities tend to be overcollateralized. Overcollateralization ensures that interest payments promised to security holders will continue even though some mortgages may be in default. 37) B

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To make an estimate of the value of mortgages in the pool (referred to as marking the mortgages to market), the trustee must value each of the mortgages in the pool by first establishing the number and outstanding balance of each mortgage in trust.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) One way that a mortgage pay-through bond (MPTB) is like a mortgage-backed bond (MBB) is that the pay-through bond is a debt obligation of the issuer. ⊚ true ⊚ false Question Details Topic : MPTB Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

2) The CMO is considered a marketing innovation as well as a financial innovation, because it is the first security in the secondary mortgage market to have run a prime-time television ad. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : CMO Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

A derivative security derives its value from another security, index, or financial claim. ⊚ true ⊚ false

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Investors retain prepayment risk on MBBs, but issuers incur this risk with MPTBs.

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⊚ ⊚

true false

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A floater is a CMO tranche that has a variable interest rate. ⊚ true ⊚ false

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6) The issuer of a mortgage pass-through bond bears all the prepayment risk of the underlying mortgages. ⊚ true ⊚ false Question Details Topic : MPTB Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

7) The CMO investor assumes the prepayment risk of the underlying mortgages, although the CMO modifies how the risk is allocated. ⊚ true ⊚ false

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Question Details Topic : CMO Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

8) In comparison to mortgage pass-through securities, CMOs attract a broader class of investors because, by prioritizing cash flows, they can offer more specific maturities. ⊚ true ⊚ false Question Details Topic : CMO Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

A CMO does not completely eliminate prepayment risk. ⊚ true ⊚ false

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10) If a premium is paid on a CMO issue (at the time of issue), yields will increase as prepayment rates accelerate. ⊚ true ⊚ false

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11) From the issuer’s perspective, the use of MBBs and MPTBs should be viewed as a method of debt financing. ⊚ true ⊚ false Question Details Topic : MPTB Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

12) Cash flows remaining after all CMO tranches have been paid off are referred to as REMICs. ⊚ true ⊚ false Question Details Difficulty : 3 Hard Topic : CMO Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 3 Apply Accessibility : Screen Reader Compatible

13)

CMO investors only pay taxes on interest income. ⊚ true ⊚ false

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14) In CMO terminology, planned amortization classes (PACs) are also known as companion tranches. ⊚ true ⊚ false Question Details Difficulty : 3 Hard Topic : CMO Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 3 Apply Accessibility : Screen Reader Compatible

15)

CDOs often include "B" notes, mezzanine debt, and preferred equity as investments. ⊚ true ⊚ false

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16) CDO managers raise capital through the issuance of rated CDO debt and equity to purchase an undiversified pool of credit instruments. ⊚ true ⊚ false

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17) In CDOs both equity and debt holders prefer riskier, higher-yielding collateral to collect excess spreads. ⊚ true ⊚ false Question Details Difficulty : 2 Medium Topic : CDO Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

18) Subprime mortgage-backed securities generally include FHA-insured or VA-guaranteed mortgages, along with conventional mortgages. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Subprime Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 19) What is the primary distinction between mortgage-related securities backed by residential mortgages and those backed by commercial mortgages?

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A) Default is the key risk with residential mortgages; prepayment is the key risk with commercial mortgages. B) Interest rate risk is the key risk with residential mortgages; prepayment is the key risk with commercial mortgages. C) Prepayment is the key risk with residential mortgages; default is the key risk with commercial mortgages. D) Prepayment is the key risk with residential mortgages; interest rate risk is the key risk with commercial mortgages.

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20) A mortgage company is issuing a CMO with three tranches, with the principal and coupon rate given in the table below. When issued, the weighted average coupon on the CMO will be which of the following? Tranche A B Z

Principal $ 40,000,000 30,000,000 30,000,000

Coupon Rate 9.25% 10.00% 11.00%

A) 9.25% B) 10.00% C) 10.08% D) 11.00%

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21)

Which of the following statements regarding subprime mortgages is TRUE?

A) Subprime mortgages are not Ginnie Mae guaranteed, so CMO investors are exposed to default risk. B) Subprime mortgages are not Ginnie Mae guaranteed, so securities backed by subprime mortgages cannot be issued. C) CMOs backed by subprime mortgages cannot be used as collateral for CDOs. D) Due to diversification, securities backed by subprime loans are of no more risk than those backed by prime loans.

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22)

The main purpose of the Term Asset-Backed Securities Loan Facility (TALF) is to:

A) buy mortgage-backed securities owned by Freddie Mac, Fannie Mae, and Ginnie Mae. B) Issue CDOs and use the proceeds to fund infrastructure projects to stimulate the economy. C) Regulate hedge funds to reduce investments in risky assets. D) Use residential loans as collateral to purchase U.S. Treasuries as a way to reduce interest rates.

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23) Which of the following statements regarding mortgage pass-through bonds (MPTBs) is FALSE? A) MPTBs can be viewed as mortgage-backed bonds with the pass-through of principal and prepayment features of a mortgage pass-through security. B) Most MPTBs are based on residential mortgage pools and are generally overcollateralized. C) MPTBs represent an undivided equity ownership interest in a mortgage pool. D) All of the choices are correct.

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24)

The credit rating of an MPTB depends largely on: A) the amount of overcollateralization. B) the degree to which government-related securities constitute the excess collateral. C) the riskiness of the mortgage in the underlying pools. D) All of the choices are correct.

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25) that:

In comparison to other mortgage-backed securities, the unique characteristic of CMOs is

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A) CMO issuers do not retain ownership of the underlying mortgage pool. B) CMOs are issued in multiple security classes. C) the CMO mortgage pool is not overcollateralized. D) CMOs are a pay-through in which all amortization and prepayments flow through to investors.

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26)

Which of the following is NOT a CMO security type? A) A repeat floater B) A Z tranche C) An inverse floater D) An IO tranche

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27)

For which of the following investments is the exact date of maturity known? A) CMOs B) MBBs C) MPTs D) MPTBs

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28)

For which of the following investments does the issuer bear all of the prepayment risk? A) CMOs B) MBBs C) MPTs D) MPTBs

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29)

Which of the following investments in NOT a debt obligation of the issuer? A) CMOs B) MBBs C) MPTs D) MPTBs

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30)

Which of the following is NOT characteristic of commercial-backed mortgage securities?

A) The underlying mortgage pool represents a variety of different property types (retail, multifamily, etc.) and a specific geographical area. B) The underlying mortgages have usually been outstanding for several years. C) One of the primary issuers of such securities are insurance companies. D) In general, the underlying mortgage pool for such securities contain fewer mortgages than are included in residential-backed mortgage pools.

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31)

REMICs were created in order to avoid taxes: A) entirely. B) at the investor level. C) at the entity level. D) but no taxes can be avoided.

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32)

Duration is defined as which of the following?

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A) A measure of the extent to which different investments expose an investor to interest rate risk. B) A measure of the weighted-average time required before all principal and interest is received on an investment. C) A measure that takes into account both the size of cash flows and the timing of their receipt. D) All of the choices are correct.

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33)

The residual position in the CMO offering is considered which kind of position? A) Primary B) Equity C) Interest D) Debt

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34) A calamity call, which allows the issuer to recall all securities for a specified time, can be used in each of the following situations EXCEPT when:

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A) investors want to cash out their positions. B) interest rates decline sharply. C) prepayments decline sharply. D) reinvestment rates are below what was promised to investors.

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35) The total interest collected from the pool will be __________ if prepayment accelerates; therefore, the dollar spread between interest inflow and outflow becomes __________. A) lower; smaller B) lower; wider C) higher; smaller D) higher; wider

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36)

Which of the following is FALSE regarding a planned amortization class (PAC) tranche? A) It has the greatest degree of cash flow certainty. B) Variable payments are received. C) Payments are received over predetermined period of time. D) Payments are received under a range of prepayment scenarios.

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Question Details Topic : CMO Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

37)

Convexity is a gauge for which of the following? A) Profitability B) Return C) Sensitivity D) Duration

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38)

Which of the following does NOT increase the noncredit risks of CDOs? A) Collateral management risk B) Certainty in average life of CDO tranches C) Higher correlation and liquidity D) All of the choices increase the noncredit risks of CDOs.

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39) Which of these items are hybrid securities that contain elements of mortgage-backed bonds and mortgage pass-throughs? A) MPTBs B) CDOs C) CMOs D) Tranches

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40) Class A investors are sometimes repaid with an accelerated pattern of cash flows and are sometimes referred to as: A) accelerated tranches. B) quick pay tranches. C) tranche residuals. D) fast pay tranches.

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41) A tranche that has a coupon interest rate that adjusts in the opposite direction to its index is referred to as a(n):

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A) reverse floater tranche. B) inverse floater tranche. C) upside-down floater tranche. D) backwards floater tranche.

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Answer Key Test name: Ch20 1) TRUE This is one similarity between and MPTB and an MBB. 2) FALSE CMOs are considered to be a marketing and financial innovation because investor concerns over unanticipated cash flow due to borrower prepayment prompted investment bankers and underwriters to innovate and develop the collateralized mortgage obligation. 3) TRUE The term derivative refers to any investment with an underlying value that is dependent upon another security, index, or pool of securities. 4) FALSE With MBBs, issu-ers bear prepayment risk by virtue of the overcollateralization requirement. In other words, as prepayments accelerate and mortgages are prepaid, more mortgages must be replaced in the pool. With MPTs, security holders bear prepayment risk because all prepayments are passed through to investors. This means that (1) MBBs should be priced to provide lower yields than MPTs because the MBB issuer bears prepayment risk and (2) as market interest rates change, the price of MBBs will not reflect accelerated prepayment rates. 5) TRUE Floating rate tranches are generally attractive to institutional investors seeking assets to match floating rate liabilities. The floater tranche, as it is often called, has coupon rates that adjust periodically to a fixed spread over an index. Version 1

6) FALSE With MPTs, security holders bear prepayment risk because all prepayments are passed through to investors. 7) TRUE The CMO is a pay-through security in that all amortization and prepayments flow through to investors. This means that the security holder continues to assume prepayment risk. However, the CMO modifies how the risk is allocated. Like both the MBB and MPTB, the difference between assets pledged as security and the amount of the debt issued against the pool constitutes the equity position of the issuer. 8) TRUE The goal of the CMO issuer: that is, to reach different market segments of investors who have more specific maturity requirements than a mortgage pass-through security provides, but who may not need the exact maturity requirements that an MBB provides. 9) TRUE The CMO is a pay-through security in that all amortization and prepayments flow through to investors. This means that the security holder continues to assume prepayment risk. However, the CMO modifies how the risk is allocated. Like both the MBB and MPTB, the difference between assets pledged as security and the amount of the debt issued against the pool constitutes the equity position of the issuer. 10) FALSE If a premium is paid on a CMO issue (at the time of issue), yields will decrease as prepayment rates accelerate. 11) TRUE

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The way that MBBs and MPTBs are structured is similar to debt financing from the perspective of the investor. Although the securitized mortgages are placed with a trustee, they are still carried as an asset on the issuer’s balance sheet while the MBBs are categorized as debt. 12) FALSE As an alternative to a CMO issue, the issuer could create a real estate mortgage investment conduit (REMIC) to achieve off-balance-sheet financing. With this vehicle, the issuer is selling the mortgage pool to investors and the transaction is completely off-balance-sheet financing. 13) TRUE Only interest income is taxable for CMO investors. 14) FALSE Prepayments in excess of the amounts specified in the sinking fund schedule will be applied to one or more of the non-PAC and non-TAC tranches in the structure, which are often called companion or support tranches because they are issued in tandem with PACs and TACs and absorb any significant variation in prepayments. 15) TRUE Mezzanine debt, preferred equity, and “B” notes are all common investments contained in CDOs. 16) FALSE By combining preferred equity from several different properties along with the other types of debt, a CDO manager can create a welldiversified asset structure for the CDO. 17) FALSE Investors always prefer the highest return that can be achieved at the lowest risk.

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18) FALSE Traditionally, the CMO structure included either FHA-insured or VAguaranteed mortgages or conventional mortgages that were designed to attract prime borrowers who had a good credit rating. 19) C Mortgage-related securities that are backed by residential mortgages primarily face prepayment risk, whereas those backed by commercial mortgages primarily face default risk. 20) B $ 40,000,000.00 $ 30,000,000.00 $ 30,000,000.00 $ 100,000,000.00

9.25% 10.00% 11.00% 10.00%

21) A One of the main factors leading to the subprime mortgage crisis of the mid-2000s was that the securities backed by subprime mortgages were not GNMA guaranteed, so investors were exposed to default risk. 22) A The main purpose of the TALF is to purchase mortgage-backed securities owned by Freddie Mac, Fannie Mae, and Ginnie Mae. 23) C Mortgage pay-through bonds (MPTBs) are issued against mortgage pools and, like MPTs, cash flows from the pool (i.e., principal and interest) are passed through to security holders. However, unlike an MPT, this security is a bond and not an undivided equity ownership interest in a mortgage pool. 24) D All of these are factors in the credit rating of MPTBs.

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25) B A CMO is issued in classes referred to as tranches with different stated maturity dates and is also referred to as a multiple security class, mortgage pay-through security. 26) A Z tranches, IO tranches, and inverse floaters are all common CMO security types. 27) B MBBs offer exact maturity dates, whereas the CMO was created to reach different market segments of investors who have more specific maturity requirements than a mortgage pass-through security provides, but who may not need the exact maturity requirements that an MBB provides. 28) B Issuers of MBBs bear all prepayment risk; hence, the extent of overcol-lateralization or credit enhancements for these securities must be greatest. 29) C The MBT is an undivided equity ownership interest in a mortgage pool and not a debt obligation. 30) A Properties serving as collateral for the mortgages in commercial-backed mortgage pools are generally the same type (i.e., either office build-ings or retail) and are geographically diverse. 31) C

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As part of the Tax Reform Act of 1986, Congress passed legislation creating real estate mortgage investment conduits (REMICs, pronounced “remmicks”). This legislation provided regulations that, if adhered to, allowed mortgage-backed offerings with multiple security classes to be issued without the risk of taxation at the entity level. 32) D One measure that has been developed to aid in the analysis is duration and it may be correctly described as all of these elements. 33) B The residual cash flow in a CMO will represent a return of an amount that is in overcollateral, or equity, invested in the venture. 34) A A calamity call allows the issuer to recall all securities for a specified time after issue in the event interest rates decline sharply, prepayments accelerate, and reinvestment rates fall below rates promised to inves-tors. 35) A In the case of faster prepayment, the BTIRR will fall versus the slower prepayment example. This occurs because the total interest collected from the pool will be lower if prepayment accelerates; therefore, the dollar spread between interest inflow and outflow becomes smaller. 36) B

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Under a sinking fund structure, a planned amortization class (PAC) tranche offers the greatest degree of cash flow certainty. Instead of being allocated all principal repay-ments from the underlying pool, the PAC receives fixed payments over a predetermined period of time under a range of prepayment scenarios. This range, or PAC band, is delineated by a minimum and maximum constant payment speed under which the PAC scheduled repayment will remain unchanged. 37) C Convexity measures sensitivity to market rates of interest (discount rates). 38) B Higher correlation and liquidity and the presence of collateral management risk increase the noncredit risks of the CDO. Increased certainty in average life would not increase risk to a debt obligation as general uncertainty in this area increases risk. 39) A MPTBs can be best described as hybrid securities or ones containing elements of both mortgage pass-throughs and mortgage-backed bonds. 40) D Based on the accelerated pattern of cash flows, Class A investors receive payment prior to Class B investors. Class A securities are sometimes referred to as the fast pay tranche. 41) B The inverse floater tranche has a coupon interest rate that adjusts in the opposite direction to its index. By setting the ratio of the floating rate tranche to inverted floating rate tranche equal to 1, the CMO issuer can ensure that the weighted-average rate of interest for the two classes will be stabilized with respect to changes in the index. Version 1

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) At least 95 percent of the value of a REIT’s assets must consist of real estate assets, cash, and government securities. ⊚ true ⊚ false Question Details Topic : REIT Legal Requirements Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 2 Medium Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

2) Funds from operation (FFO), is calculated by adding back depreciation, amortization, and other noncash deductions to earnings. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : REIT Financial Issues Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

3) A mortgage REIT is a REIT that primarily invests in mortgages rather than equity ownership. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : Types of REITs Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

The United States is the only country that allows REITs (or similar investments).

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⊚ ⊚

true false

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Mortgage REITs use debt financing to increase their capital bases. ⊚ true ⊚ false

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6) REITs are required to pay out 90 percent of their earnings as dividends or they will face penalties. ⊚ true ⊚ false Question Details Topic : REIT Legal Requirements Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 2 Medium Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

7) The difference between EPS (earnings per share) and FFO (funds from operations) is the interest deduction. ⊚ true ⊚ false

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Usually ground leases are for relatively short periods of time. ⊚ true ⊚ false

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REITs can sometimes capitalize rather than lease certain expenditures to increase FFO. ⊚ true ⊚ false

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10)

Because REITs are corporations, they are subject to double taxation. ⊚ true ⊚ false

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11)

A REIT must have at least 200 shareholders. ⊚ true ⊚ false

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12)

A portion of a REITs dividend may be a nontaxable return of capital. ⊚ true ⊚ false

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13) Real estate assets, cash, and government securities must represent at least 75 percent of REIT assets. ⊚ true ⊚ false

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14)

REITs must be passive investments with external advisors. ⊚ true ⊚ false

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15) A blended capitalization rate is an average of the capitalization rates that would be used for the individual properties in a portfolio if each was being valued separately. ⊚ true ⊚ false Question Details Accessibility : Keyboard Navigation Gradable : automatic Difficulty : 1 Easy Topic : REIT Financial Requirements Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 16) Net Revenue Less: Operating expenses

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$ 20,000,000

9,800,000

Depreciation and amortization Income from operations Less: Interest expense Net income

4,400,000 5,800,000

$ 1,280,000 $ 4,520,000

Consider the financial statements for a REIT, given above. Price multiples for comparable REITs are about 10 times current funds from operation (FFO). What price does this suggest for the REIT’s shares if 1,000,000 shares are issued? A) $4.52 per share B) $45.20 per share C) $8.92 per share D) $89.20 per share

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17)

The most common type of REITs in today’s market are: A) equity trusts. B) mortgage trusts. C) hybrid trusts. D) partnership trusts.

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18)

Which of the following regarding private (unlisted) REITs is TRUE?

A) Unlisted REITs are less expensive than listed REITs. B) Unlisted REITs are less liquid than listed REITS. C) Unlisted REITs are more subject to short-term market price volatility than listed REITS. D) "List or liquidate" provisions in unlisted REITs make such REITs less risky than listed REITS.

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19) A REIT has an NOI of $15 per share and currently pays a dividend of $10 per share. The dividend is projected to increase by 4 percent by next year and continue to increase by 4 percent per year thereafter. Assuming that the blended cap rate is 9.75 percent and the required rate of return is 10.5 percent, what value would the Gordon dividend discount model provide? A) $60.15 B) $71.89 C) $153.85 D) $160.00

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20) A REIT has an NOI of $15 per share and currently pays a dividend of $10 per share. The dividend is projected to increase by 4 percent by next year and continue to increase by 4 percent per year thereafter. Assuming that the blended cap rate is 9.75 percent and the required rate of return is 10.5 percent, what would be the net asset value (NAV) of the REIT? A) $60.15 B) $71.89 C) $153.85 D) $160.00

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21)

Which of the following is NOT a current type of REIT? A) Mortgage trust B) Equity trust C) Hybrid trust D) Neither mortgage trust nor hybrid trust are REITs.

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22) Hybrid REITs, which are no longer tracked by NAREIT, are comprised of what primary classifications of REITs?

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A) UPREITs, mortgage B) Mortgage, equity, retail C) Mortgage, equity D) Healthcare, retail, office

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23) A REIT with 100 shares outstanding earns $1,000 in rent and incurs operating expenses of $400. In addition, the REIT owns property with an historic cost of $6,000 and depreciates it over a 15-year period using straight-line depreciation. What are the funds from operations per share and the earnings per share for this REIT? A) $4 and $3, respectively B) $4 and $2, respectively C) $6 and $2, respectively D) $6 and $3, respectively

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24) A REIT with 100 shares outstanding earns $1,000 in rent and incurs operating expenses of $400. In addition, the REIT owns property with an historic cost of $6,000 and depreciates it over a 15-year period using straight-line depreciation. At the very least, what dividend payment must it make to maintain its tax exempt status?

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A) $1.80/share B) $2.00/share C) $3.60/share D) $5.40/share

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25) An investor pays $63.00 per share for stock in a given REIT. The REIT declares a dividend of $4.00 per share and has an EPS of $2.37. Considering the recovery of capital (ROC), what is the new cost basis of the stock acquired by the investor? A) $60.63 B) $61.37 C) $63.00 D) $64.63

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26)

Which of the following is NOT a requirement of REITs?

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A) A REIT must have at least 100 stockholders. B) Not more than 50 percent of a REIT's shares can be owned by five or fewer shareholders. C) At least 90 percent of a REIT's income must be distributed to shareholders. D) All of the choices are REIT requirements.

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27) Which of the following REIT types is organized to acquire the specific property or properties described in its prospectus? A) A property trust B) A mixed trust C) A purchasing trust D) An exchange trust

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28)

Which of the following REIT types is NOT likely to own real property? A) Hybrid REIT B) Mortgage REIT C) Equity REIT D) All of the choices are likely to own real property.

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29)

Which of the following is likely to occur upon the sale of a REIT-owned property?

A) If a capital gain is realized, the REIT can retain the gain for future investment and be taxed at the appropriate corporate capital gains tax rate. B) If a capital gain is realized, the REIT can retain the gain for future investment and be taxed at the shareholder's capital gains tax rate. C) If a capital gain is realized, the REIT can distribute the gain as a dividend to shareholders who will realize it as dividend income for individual tax reporting purposes. D) If a capital loss is realized, the loss can be passed through to individual investors.

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30)

The funds from operations (FFO) for a REIT is roughly equal to: A) NOI less interest deductions. B) earnings before tax plus noncash expenses. C) NOI plus interest deductions. D) earnings per share plus capital gains.

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31) Once an entity has been terminated as a REIT, the entity cannot make a new election to be taxed as a REIT until ________ years after the termination. A) 2 B) 3 C) 4 D) 5

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32)

The difference between EPS (earnings per share) and FFO (funds from operations) is: A) irrelevant. B) determined by growth of the company. C) due to depreciation and amortization. D) due to the number of shares outstanding.

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33) REIT dividends are considered __________ income and thus do not qualify as passive income to offset passive losses. A) portfolio B) operating C) trading D) outside professional

34)

Recovery of capital (ROC) results in a(n): A) increase in the dividend available to the investor. B) increase in the value of the stock. C) reduction in the cost basis of acquired stock. D) reduction in losses on the stock.

35) The growth of the REIT industry in the early 1970s was mainly attributed to which of the following?

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A) Mortgage trust loans were less regulated than bank loans B) Increased interest rates C) Declined performance of other investments D) Increased value of real property throughout the country

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36) Which of the following represents the space that is currently being rented to paying tenants? A) Leased space B) Occupied space C) Ground space D) REIT space

37) An arrangement in which a REIT collects a stream of rents from a building owner, then makes a lower, and sometimes fixed, payment to the landowner is a: A) fixed investment. B) REIT spreading. C) spread investing. D) renewal option.

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Answer Key Test name: Ch21 1) FALSE At least 75 percent of the value of a REIT's assets must consist of real estate assets, cash, and government securities. 2) TRUE FFO is derived by adding all noncash expenses to net income (loss). Noncash accounting charges generally include depreciation and amortiza-tion. 3) TRUE Mortgages REIT invest mainly in mortgages. 4) FALSE The REIT market is continually evolving as new investment alternatives emerge and mature. A recent development has been the emergence of international REIT investments. 5) TRUE Debt financing is a key component for mortgage REITs as it allows them to expand their capital bases and, thus, increase growth opportunities. 6) TRUE Distributions to shareholders must equal or exceed the sum of 90 percent of REIT taxable income. 7) FALSE FFO is calculated as the earnings before tax plus noncash expenses (depreciation and amortization). Version 1

8) FALSE Ground leases encumber the land underneath buildings. They are typically made for long periods of time, sometimes up to 99 years. 9) TRUE REITs are permitted to capitalize certain expenditures which results in increased FFO. 10) FALSE The structures of REITs are largely dependent on the tax law of each country as it is essential for REITs to serve as nontaxable conduits for tax purposes and that there be no double taxation at the REIT level and investor level specifically for the REIT investment. 11) FALSE 12) TRUE REITs are permitted to distributed dividends, a portion of which may not be subject to taxes. 13) TRUE At least 75 percent of the value of a REIT’s assets must consist of real estate assets, cash, and government securities. 14) FALSE The vast majority of today’s equity REITs are self-advised, vertically integrated oper-ating companies. They actively manage their portfolios in an effort to grow their cash flow and their portfolios. 15) TRUE A blended capitalization rate means one that is an average of the capitalization rates that would be used for the individual properties in the portfolio if we were valuing each property separately. 16) D Version 1

FFO for the given REIT is $4,520,000 + $4,400,000 = $8,920,000. Taking into account the multiple and number of shares issued, the suggested price is $8,920,000 × 10 times = $89,200,000/1,000,000 shares = $89.20 per share. 17) A Up until the 1970s, the equity trust was the most prevalent type of REIT, but during the mid-1970s, the mortgage trust became more important. More recently, the equity trust has again grown in importance and is now the dominant REIT type by both number and market capitaliza-tion figures. 18) B Critics suggest that unlisted REITs are very expensive and illiquid compared to listed REITs. 19) D The value according to the Gordon dividend discount model is found byV = D1/(K − g) = (10 × 1.04)/(0.105 − 0.04) = $160.00. 20) C NAV = NOI/r wherer is the blended cap rate, so =15/0.0975 = $153.85. 21) C The two principal types of publicly traded real estate trusts are equity trusts and mortgage trusts. Prior to 2010, there was a third classification, hybrid REITs, which generally con-sisted of REITs with a mix of equity and debt real estate investments. As of December 17, 2010, NAREIT discontinued tracking these REITs, as only four hybrid REITs remained at that time. 22) C

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The two principal types of publicly traded real estate trusts are equity trusts and mortgage trusts. Prior to 2010, there was a third classification, hybrid REITs, which generally con-sisted of REITs with a mix of equity and debt real estate investments. As of December 17, 2010, NAREIT discontinued tracking these REITs, as only four hybrid REITs remained at that time. 23) C EPS = Earnings/Shares outstanding = ($1,000 − $400)/100 = $6.00. The difference in EPS and NOI is the annual depreciation allowance, so = [$1,000 − $400 − ($6,000/15)]/100 = $2.00. 24) A Distributions to shareholders must equal or exceed the sum of 90 percent of REIT taxable income. The REIT’s NOI = [$1,000 − $400 − ($6,000/15)]/100 = $2.00/share, so the minimum dividend is $2.00 × 90% = $1.80/share. 25) B The new cost basis = $63 − $4 + $2.37 = $61.37 26) D Among others, the three listed requirements are necessary for a REIT to maintain its status. 27) C The purchasing trust is organized to acquire the specific property or properties described in the prospectus. 28) B Mortgages REIT invest mainly in mortgages and not in real property. 29) A

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One of the benefits for REITs is that when the REIT sells owned property and realizes a capital gain, then the REIT can retain the gain for future investment and be taxed at the appropriate corporate capital gains tax rate. 30) B FFO is calculated as the earnings before tax plus noncash expenses (depreciation and amortization). 31) D In the event that an entity fails to qualify as a REIT or voluntarily revokes its REIT status, the entity’s election to be taxed as a REIT terminates for that and subsequent years. Once this termination has occurred, the entity cannot make a new election to be taxed as a REIT until five years after the termination date. 32) C FFO is calculated as the earnings before tax plus noncash expenses (depreciation and amortization). 33) A The passive loss limitation provision does not materially affect REITs because their losses cannot be passed through to investors. REIT dividends are considered to be portfolio income and thus do not qualify as passive income to offset passive losses. 34) C ROC serves to reduce the cost basis of the stock acquired by the investor. 35) A

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During the late 1960s and early 1970s, the mortgage REIT was used as a source of loans, particularly for construction and development that were beyond the legal or policy limits of the highly regulated banks, savings and loans, insurance companies, or other real estate– oriented financing institutions. Because their lending policies were relatively unregulated and because they had access to public securities markets, mortgage REITs were in a posi-tion to fill a void in the real estate financing market. 36) B Occupied space quantifies the space for which tenants are now paying rent. Leased space includes all space for which leases are signed, even if the lease does not go into effect for another six to twelve months. 37) C Spread investing occurs when the REIT takes the risk of collecting a stream of rents from the building owner and pays a lower and perhaps fixed payment to the landowner.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) It is more difficult to compare the investment performance of real estate versus stocks and bonds. ⊚ ⊚

true false

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2) The NCREIF Property Index measures the investment performance of real estate by using actual sale prices. ⊚ true ⊚ false Question Details Topic : Portfolio Considerations Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

3) Much like the securities markets, there is a large, centralized collection of real estate transactions and operating income data. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Portfolio Considerations Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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4) The NCREIF Property Index includes property value increases or decreases only when properties are sold since the sale price is the only true measure of market value. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Portfolio Considerations Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

Both levered and unlevered properties are included in the NCREIF Property Index. ⊚ true ⊚ false

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6) An investor in a mortgage REIT is basically buying equity shares of an entity whose assets are mainly mortgages. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Portfolio Considerations Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

7) When used to evaluate the performance of an investment, the geometric mean is considered to be superior to the arithmetic mean.

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⊚ ⊚

true false

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8) When comparing investment alternatives, the standard deviation is deemed to be a measure of risk. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Performance Evaluation Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

9) The optimal portfolio is obtained by combining a group of securities which, by themselves, offer the highest returns with the lowest risk. ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

10) As long as the coefficient of correlation between two stocks is less than +1, some reduction in risk can be obtained by combining the securities. ⊚ true ⊚ false

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11) If two securities have the same positive mean returns and they are perfectly negatively correlated, an investor in such securities will earn a positive return with zero risk. ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

12) In comparison to investment portfolios comprised entirely of corporate stocks and bonds, portfolios which include some form of real estate investment tend to offer higher returns for the same level of risk. ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

13) The sources of data for real estate performance evaluation are security prices for REIT shares and the value of individual properties that are owned by pension plan sponsors. ⊚ true ⊚ false

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14) The holding period return and geometric mean return calculations will yield the same result for holding periods longer than two years. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Performance Evaluation Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 15) Consider an investment held over three years with a return of +20 percent in the first year, −25 percent in the second year, and +20 percent in the third year. What is the arithmetic mean return on the investment? A) −2.6% B) +2.6% C) +5.0% D) +8.0%

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16) Consider an investment held over three years with a return of +20 percent in the first year, −25 percent in the second year, and +20 percent in the third year. What is the geometric mean return on the investment? A) −2.6% B) +2.6% C) +5.0% D) +8.0%

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17) What statistical concept do many portfolio managers use to represent risk when considering investment performance? A) The standard deviation of returns B) The difference, or "spread," between the highest value over the holding period and the lowest value over the holding period C) The geometric mean return D) The coefficient of variation

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18) Why does including REITs in a portfolio containing S&P 500 securities produce diversification benefits? Version 1

A) Real estate investment returns are highly correlated with returns for stocks. B) Real estate investment returns are not highly correlated with returns for stocks. C) Real estate investment returns are not subject to federal income taxes. D) Real estate investment returns do not change much from year to year.

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19)

Assume you have a choice between investing in either an equity REIT, Microsoft stock (MSFT), or a combination of the two. Which point in the figure above is NOT on the efficient portfolio frontier? A) A B) B C) C D) All points are on the efficient portfolio frontier.

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20)

The data sources used to produce investment returns on investment properties include: A) the National Association of Real Estate Professionals (NAREP). B) the National Association of Real Estate Investment Trusts (NAREIT). C) the National Board of Realtors (NBR). D) all of the above.

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21)

The NCREIF Property Index can be characterized by each but which of the following?

A) Quarterly rates of return are calculated for all properties included in the index. B) The information used in compiling the index is contributed by members of the NCREIF. C) The index reflects payments to both property managers and portfolio asset managers. D) All of the above are true.

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22) On January 1st, an investor purchases Security A for $105. Over the next four months, dividends totaling $15 were paid on Security A. On March 31st, Security A was sold for $120. What is the holding period return for Security A?

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A) 0.0% B) 14.3% C) 25.0% D) 28.6%

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23)

Geometric mean returns are:

A) simple averages of holding period returns. B) expressed as compound rates of interest. C) more applicable when no specific time interval is considered to be any more important than another. D) widely used in statistical studies spanning very long periods of time.

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24) Regarding real estate investments, risk that is associated with the type of property and its location, design, lease structure, and so on can be thought of as: A) marketability risk. B) liquidity risk. C) unsystematic risk. D) Interest rate risk.

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25)

The coefficient of variation, also known as the risk-to-reward ratio, is defined as: A) the standard deviation of returns divided by the mean return. B) the variance of return multiplied by the mean return. C) the variance of returns divided by the standard deviation of returns. D) none of the above.

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26) Which of the following provides a measure of the extent to which returns tend to move together or have no relationships? A) The coefficient of determination B) The variance C) The coefficient of variation D) The coefficient of correlation

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27) If the returns of two securities are compared over time and there appears to be no relationship between their movements, what is the likely value of their coefficient of correlation? A) +1 B) −1 C) 0 D) +∞ (infinity)

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28) Assume a portfolio is comprised of two securities, A and B, whose standard deviations are 0.0412 and 0.0721, respectively. If their covariance is 0.002, what is their coefficient of correlation? A) 0.005 B) 0.115 C) 0.673 D) 1.485

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29) The optimal combination of securities that provides the greatest amount of return for each level of risk is known as:

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A) the expected frontier. B) the economic frontier. C) the efficient frontier. D) none of the above.

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30) The unit of measure that is used by portfolio managers to measure returns for individual securities on a periodic basis is the: A) return on investment (ROI). B) holding period return (HPR). C) geometric mean return. D) arithmetic mean return.

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31)

The variability on an asset’s returns represents: A) flexibility. B) profitability. C) risk. D) default.

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32)

One would see the greatest amount of diversification from two securities that are: A) positively correlated. B) negatively correlated. C) not correlated. D) perfectly correlated.

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33) Which of the following is a major property category associated with the NCREIF Property Index? A) Apartment complexes B) Office buildings C) Hotels D) All of the above are associated with the NCREIF Property Index.

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Answer Key Test name: Ch22 1) TRUE Performance information for stocks and bonds is readily available, whereas finding sales prices and original purchase values of real estate is more difficult. 2) FALSE The data incorporated in the NCREIF Property Index are based on the performance of properties managed by members of the National Council of Real Estate Investment Fiduciaries. Quarterly rates of return are calculated for all properties included in the index and are based on two distinct components of return: (1) net operating income less capital expenditures, and (2) quarterly changes in property market value (appreciation or depreciation). 3) FALSE Performance information for stocks and bonds is readily available via centralized platforms, whereas finding sales prices, original purchase values, and operating income of real estate is more difficult. 4) FALSE The data incorporated in the NCREIF Property Index are based on the performance of properties managed by members of the National Council of Real Estate Investment Fiduciaries. Quarterly rates of return are calculated for all properties included in the index and are based on two distinct components of return: (1) net operating income less capital expendi-tures, and (2) the quarterly change in property market value (appreciation or depreciation).

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5) TRUE The NCREIF includes both property types, though, when comparing to REITs and U.S. stocks, it is better to include only the NCREIF properties that have leverage. 6) TRUE A mortgage REIT is comprised of mortgages. 7) TRUE The geometric mean is used by portfolio managers when considering the performance of an investment and is expressed as a compound rate of interest from the beginning to the end of a specific period of time. Arithmetic mean returns are simple averages (not compounded) and are widely used in statistical studies spanning very long periods of time. 8) TRUE One approach that may be used to consider risk and returns is to compute the coef-ficient of variation of the returns. This is defined as the standard deviation of returns divided by the mean return (this can be based on either the arithmetic or geometric mean returns for a given investment or investment index). 9) FALSE The optimal portfolio represents the most efficient combination of securities that provides investors with maximum portfolio returns as portfolio risk increases. 10) TRUE

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Anytime the correlation between returns on two assets is less than +1, some reduction in risk (standard deviation) may be obtained by com-bining investments, as opposed to holding one investment (or one portfolio) with higher standard deviation than the prospective investment. However, the potential for risk reduc-tion is much greater as the correlation approaches −1. 11) TRUE If two securities have the same positive mean returns and these returns are perfectly, negatively correlated (e.g., −1), then it may be inferred that an inves-tor can earn a positive portfolio return with zero risk if both investments are purchased (the standard deviation of the combined returns is zero). 12) TRUE Adding real estate increases diversification, which results in a portfolio that is closer to the optimal portfolio, so adding real estate tends to increase returns for the same risk level. 13) TRUE There are two main sources for real estate returns. The first is security prices as represented by real estate investment trust (REIT) shares. The second data source is based on estimates of value of individual properties owned by pension plan sponsors. 14) FALSE The geometric mean return is calculated by first adding 1 to each of the quarterly holding period returns. This is necessary to capture the compounding of returns. Therefore, the returns will not result in the same values as the length of time increases. 15) C = (20% − 25% + 20%)/3 = 5% Version 1

16) B = [(1 + 0.2)(1 − 0.25)(1 + 0.2)](1/3)−1 Note that the GEOMEAN() function in Excel cannot work with values that are less than zero. 17) A One approach that may be used to consider risk and returns is to compute the coef-ficient of variation of the returns. This is defined as the standard deviation of returns divided by the mean return (this can be based on either the arithmetic or geometric mean returns for a given investment or investment index). 18) B There are diversification benefits of including real estate in a portfolio with stocks and bonds because real estate is not highly correlated with stocks and bonds. 19) A There are points on the curve that are directly above Point A. This means that you are able to achieve a higher expected return with the same level of risk as Point A, so Point A is not on the efficient portfolio frontier.

20) B One of the two sources of data used to produce investment returns on real estate is based on REITs. The National Association of Real Estate Investment Trusts REIT Share Price Index (NAREIT Index) is a monthly index based on ending market prices for shares owned by REIT investors. 21) C Quarterly rates of return are calculated for all properties included in the index and are based on two distinct components of return: (1) net operating income less capital expendi-tures, and (2) the quarterly change in property market value (appreciation or depreciation). Version 1

22) D = Holding period returns include the gain on sale of the stock and the dividends, or ($120 − $105 + $15)/$105 = 0.286, or 28.6%. 23) B The geometric mean is calculated by multiplying all the return rela-tives and then finding the nth root. Then 1 is subtracted from this result. Thus, this is a measure of the compounded interest rate. 24) C Unsystematic risk or idiosyncratic risk is a result of factors that tend to be unique to an asset that cause it to not be cor-related with other assets. 25) A One approach that may be used to consider risk and returns is to compute the coef-ficient of variation of the returns. This is defined as the standard deviation of returns divided by the mean return (this can be based on either the arithmetic or geometric mean returns for a given investment or investment index). This concept is sometimes referred to as a risk-to-reward ratio and is intended to relate total risk, as represented by the standard deviation, to the mean return with the idea of determining how much return an investor could expect to earn relative to the total risk taken if the investment was made. 26) D The coefficient of correlation is used to obtain this relative measure or the extent to which one set of numbers moves in the same or opposite direction with another series. 27) C If the correlation coefficient is close to zero, the implication is that no relation-ship exists between the two series.

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28) C ρij = COVij ÷ (σi σj) =0.002/(0.0412 × 0.0721) = 0.673. 29) C The efficient frontier. It represents the most efficient combination of securities that provides investors with maximum portfolio returns as portfolio risk increases. 30) B The most fundamental unit of mea-sure used by portfolio managers to measure investment returns for individual securities, or a class of securities in a portfolio, is the holding period return (HPR). 31) C The variability of holding period returns for specific assets or classes of assets enables one to make a better compari-son among investments exhibiting different risk. 32) B As the coefficient approaches −1, the series are negatively correlated because they move in exactly opposite directions. Hence, given a change in one series, the other would be expected to move in the opposite direction. 33) D The NCREIF Index contains data on five major property categories: apartment complexes, office buildings, industrial (warehouses, office/showrooms/research and development facilities), retail properties (including regional, community, and neighborhood shopping centers as well as freestanding store buildings), and hotels.

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TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Investments that are held "in trust" on behalf of a pension plan’s beneficiaries cause the fiduciary duties and responsibilities of pension plan sponsors to "carry over" to managers of these real estate investment funds. ⊚ true ⊚ false Question Details Topic : Investor Objectives Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

2) In a well-diversified investment portfolio, the allocation of real estate investments should not exceed five percent. ⊚ true ⊚ false Question Details Topic : Investor Objectives Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

3) Opportunity funds are designed for long-term investment and, accordingly, will generally maintain ownership of acquired properties for several years. ⊚ true ⊚ false Question Details Topic : Fund Offerings Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

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4) A new real estate investment fund might feature a "lock-up period" that would prohibit investors from exiting the fund during the fund’s first year or two in operation. ⊚ true ⊚ false Question Details Topic : Fund Offerings Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

5) The investment strategy of a fund may exclude certain markets, submarkets, and/or property categories from the fund manager’s investment options. ⊚ true ⊚ false Question Details Topic : Fund Offerings Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

6) Compared to stock and bond funds, real estate investment funds are typically much easier to value due to the availability of real estate appraisals. ⊚ true ⊚ false Question Details Difficulty : 1 Easy Topic : Performance Evaluation Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

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7) In reporting on a fund’s investment performance, managers are generally permitted to provide investors with internally performed appraisals at specific time intervals. Third-party, external appraisals are required only when a property is sold. ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

8) When reporting on a real estate investment fund, a manager may treat the financial information as an estimate of performance based on the assumption that all of the underlying properties could be sold at their appraised value. ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

9) Unrealized returns are important to investors in assessing the performance of their investments and of their fund manager(s). ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

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10) Investors may use attribution analysis to examine why the performance of an actively managed real estate investment fund has exceeded its benchmark return. ⊚ true ⊚ false Question Details Topic : Performance Evaluation Difficulty : 2 Medium Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 2 Understand Accessibility : Screen Reader Compatible

11) Value-add funds take on less risk than core funds by purchasing only properties with very low vacancies and stable tenants. ⊚ true ⊚ false Question Details Topic : Fund Offerings Difficulty : 1 Easy Accessibility : Keyboard Navigation Gradable : automatic Bloom's : Level 1 Remember Accessibility : Screen Reader Compatible

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 12) Large, private funds are typically created by real estate investment managers who develop an investment strategy involving which of the following? (1) The types of properties to be acquired and markets where acquisitions will be made (2) How the fund will be operated (3) When properties are to be sold (4) How the fund strategy will align with the real estate investment requirements of investors A) 1, 2, 3 B) 1, 2, 4 C) 2, 3, 4 D) All of the above

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13) Which of the following documents is used to inform real estate fund investors of the discretion that managers may exercise related to the acquisition, management, and sale of properties in the fund ? A) Fund agreement B) Prospectus C) Due diligence record D) Deed of trust

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14) Which of the following is NOT one of the typical categories of real estate investment funds? A) Core funds B) Value-add funds C) Growth funds D) Opportunity funds

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15) __________ funds take on risks by conducting ground up development projects that expose the funds to additional construction risks, such as entitlements, construction delays, cost overruns, complex JV management issues, and so on, and use a relatively high degree of financial leverage. A) Core B) Opportunity C) Value-add D) Core plus

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16) A __________ fund structure is commonly used by managers of very large, open-end funds that are expected to hold a substantial number of properties in various locations. A) commingled B) separate C) conjoined D) adjacent

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17) Which type of fund structure would investment managers be likely to use in order to raise a specific amount of capital over a specific period of time? A) Open-end fund B) Closed-end fund C) Finite fund D) Liquidation fund

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18) A core strategy typically uses the type of fund structure under which new investors may be admitted after the initial offering and after the commencement of fund operations. These funds are referred to as: A) closed-end funds. B) finite funds. C) liquidation funds. D) open-end funds.

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19) Investors may be concerned if a fund manager deviates from the stated investment strategy by purchasing properties that do not fall within the parameters of the stated objectives of the firm. This practice is referred to as: A) overage. B) plan deviation. C) style drift. D) eccentricity.

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20) Fund managers generally include a __________ policy in the fund documents specifying conditions under which investors may exit the fund. A) recovery B) recuperative C) reclamation D) redemption

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21) During the period before a fund manager begins to physically purchase properties, investors are typically asked to make capital ________. A) calls B) commitments C) contributions D) assurances

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22) Which of the following is NOT a type of fee commonly charged by a real estate investment fund manager? A) Acquisition fees B) Disposition fees C) Commitment fees D) Performance fees

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23) Given the following fee structure, what is the total amount of fees that would be paid to a fund manager if the actual NOI was $45 million annually? 5.5 percent up to $20 million in annual NOI 5.0 percent for the next $15 million in annual NOI 4.5 percent for the next $10 million in annual NOI 4.0 percent for all over $45 million in annual NOI A) $2.3 million B) $1.1 million C) $2.0 million D) $1.8 million

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24) If a fund manager has the opportunity to receive a fee as an added incentive to enhance the performance of the fund, the amount of the fee may be based on the extent to which the performance of the fund exceeds an agreed upon hurdle rate of return. Such a fee is referred to as a: A) bonus. B) hurdle fee. C) fiduciary fee. D) promote.

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25) Fund flows that occur within a quarterly reporting period are referred to as __________ cash flows. A) inter-period B) intra-period C) regular D) irregular

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26) When comparing investment returns at the fund level against those at the property level, the difference between them is referred to as __________. A) fund drag B) performance lag C) leverage drag D) cash drag

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27) __________ is the rate that causes the present value of all cash flows from a property (including its resale value) to be equal to the original purchase price of the property. A) IRR B) NPV C) TWR D) TVM

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28) A property was acquired for $950,000 and then produced cash flows of $100,000, $120,000, $135,000, $135,000, and $125,000 at the end of Years 1 through 5, respectively. The property was then sold for $1,200,000 at the end of the fifth year. What was the internal rate of return for this investment? A) 16.0% B) 16.5% C) 15.5% D) 12.8%

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29) For real estate investment funds in which the manager has little control over the flow of cash into and out of the fund, the preferred performance measure is __________. A) NPV B) IRR C) TVM D) TWR

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30)

Which of the following is NOT a measure of risk related to real estate investment funds? A) Tracking error B) Beta C) TWR D) Jensen’s alpha

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31) What is the expected return for a real estate investment fund with a beta of 1.87, given a risk free rate of 2.7 percent and an expected return of 11.2 percent for the market? A) 18.6% B) 11.2% C) 15.9% D) 2.7%

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32) Well-known market indexes that are adjusted by a margin serve as which of the following in relation to the expected returns of a fund? A) Target return B) Opportunity C) Benchmark D) TWR

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33) __________ funds mostly invest in existing operating properties that are stable, with low vacancy and current cash flows and are located in major metropolitan areas.

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A) Core B) Core plus C) Value-add D) Opportunistic

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34) An office complex was acquired for $1,500,000 in 2017. Cash flows to the investor were received at the end of each year, as follows: 2017 - $250,000; 2018 - $400,000; 2019 - $600,000; 2020 - $600,000. The property was sold for $1,850,000 at the end of 2020. Calculate the IRR for this property. A) 7.8% B) 27.7% C) 31.6% D) 34.3%

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Answer Key Test name: Ch23 1) TRUE Investments in many of the funds are held in trust on behalf of pension plan beneficiaries. This means that fiduciary duties and responsibilities of pension plan sponsors to pension beneficiaries carry over to managers of these real estate invest-ment funds. 2) FALSE When evaluating which private real estate investment funds to invest in, investors have to keep in mind their investment objectives, that is, what do they want to accomplish with their real estate allocation and what role will real estate fulfill within their overall invest-ment portfolio. These goals are generally expressed in terms of risk that investors are will-ing to assume and the investment returns (reward) that they expect to earn for risk-taking. Investors in funds must evaluate whether properties to be acquired by the fund are consis-tent with their portfolio objectives. 3) FALSE These funds typically use a relatively high degree of financial leverage. Many of these distressed asset funds may be designed as short-term investments and may sell properties that are acquired within a relatively short period of time. 4) TRUE Many of these funds will have a lock-up period (typically one to two years during the initial stage of the fund) where investors’ exit from the fund is not permitted.

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5) TRUE The investment strategy of a fund also may identify its target markets, submarkets, and property categories in which investments will be made. For example, a fund could include certain geographic areas and may specifically exclude certain markets (e.g., properties in non- U.S. countries). 6) FALSE Real estate investment funds are unlike stock and bond funds in many ways. One very important difference is that the latter funds can be valued more easily. This is because stocks and bonds are traded very frequently, and prices for these securities are usually available. Private real estate values cannot be determined as easily or as often. 7) FALSE While fund managers may be allowed to provide investors with estimates of value (internal appraisals) from time to time, external appraisals done by third-party appraisers are usually required at specific time intervals. 8) TRUE When reporting investment performance, fund managers frequently use property appraisals to estimate value. 9) TRUE Performance returns (realized or unrealized) are very important to all parties involved with the operation of the fund because investors use return data to assess how well their investments and the fund manager are performing. 10) TRUE

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When actual results either over- or under-perform expected returns, investors and analysts may want to determine why. This question may be answered by using attribution analysis. 11) FALSE Value-add funds take on more risks than core funds by purchasing properties that either have some current vacancies or have upcoming major tenant rollovers and/or are in need of some reno-vation and capital improvement. 12) D Typically, the large, private funds are created by real estate investment managers who develop an investment strategy involving (1) the types of properties to be acquired and markets where acquisitions will be made, (2) how the fund will be operated, (3) when properties are to be sold, and (4) how the fund strategy will align with the real estate investment requirements of investors. 13) A The fund agreement is used to document, identify, and disclose to investors the investment strategies, the types of proper-ties and locations where acquisitions will occur, exit strategies, and so on. It also provides guidance to investors as to the discretion that managers will have when acquiring, manag-ing, and selling real estate assets as they operate the fund. 14) C Core, value-add, and opportunity funds are all common types of real estate investment funds. 15) B

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Opportunity funds take on even more risks by doing “ground up development projects” that expose funds to additional construction risks, such as entitlements, construction delays, cost overruns, complex JV management issues, and so on. These funds typically use a relatively high degree of financial leverage. Many of these distressed asset funds may be designed as short-term investments and may sell properties that are acquired within a relatively short period of time. 16) A When a very large fund is created and expected to contain a large number of prop-erties in many locations, a commingled fund structure is often used by managers and then marketed to many institutional investors. These large, commingled funds are typically open-end funds. 17) B Closed-end funds seek to raise a specific amount of capital over a specific period of time, after which the fund is closed to new investors. These funds usually require a significant mini-mum investment amount per investor. 18) D Large, commingled funds are typically open-end funds. This means that after the initial offering and after the fund commences operation, new investors may be admitted on the basis of the values of unit shares in the fund at that time. 19) C When fund managers deviate from their stated strategy and acquire properties that do not conform to the stated objectives of the fund, this is called style drift and can be a concern for investors. 20) D

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Many funds adopt a redemption policy to establish the exit order (queue) to deal with the possible situation where multiple investors choose to exit at the same time. 21) B Most funds also differentiate between investor capital commitments and investor capital contributions. The former usually relates to the time during which investors have made capital commitments to the fund but before the fund has commenced actual property acqui-sitions. The former usually refers to the amount of capital allocation that the investor com-mits to the fund manager to be deployed in making property acquisitions. 22) C Fees charged by investment fund managers generally fall into one or more of the following categories: acquisition fees, disposition fees, management fees, and performance fees (aka incentive fees, “promotes,” and “carried interests”). 23) A $20M × 0.055 $15M × 0.050 $10M × 0.045 Total fees

= $1.10M = $0.75M = $0.45M = $2.30M

24) D A promote is a fee paid to fund managers as an added incentive to enhance fund performance. The fee is usually charged toward the end of the life of fund or until 100 percent of investor’s capital has been returned. 25) B Fund flows occurring within a quarterly reporting period are often referred to as intra-period cash flows. Version 1

26) D The use of debt by the fund in this example has resulted in favorable leverage, which has increased the gross of fee fund return. On the other hand, the fund cash balance is not earning any inter-est which lowers the return. This is referred to as “cash drag.” 27) A The IRR is the rate that makes the present value of the cash flows including the resale price equal to the initial purchase price. 28) B CF0 = −$950,000 CF1 = $100,000 CF2 = $120,000 CF3 = $135,000 CF4 = $135,000 CF5 = $1,325,000 = ($125,000 + $1,200,000) Compute IRR = 16.5% 29) D When the fund manager has no control over how much individual investors invest or withdraw each year and, thus, no control over the timing of the investments, the TWR is the best measure of the manager’s performance. 30) C The TWR is a method of calculating historical returns. It does not measure risk. 31) A Rfund = 2.7% + (11.2% − 2.7%) × 1.87 = 2.7% + 15.9% = 18.60% 32) C

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A benchmark is readily determined from a well-known market index, adjusted by a margin or spread. 33) A Core funds primarily invest in stabilized existing operating properties with current cash flows, low vacancy, and major metropolitan area locations. 34) C F0 = −$1,500,000 CF1 = $250,000 CF2 = $400,000 CF3 = $600,000 CF4 = $2,450,000 = ($600,000 + $1,850,000) Compute IRR = 31.6%

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