4 Suppose that, in the next three months, the market rate of interest rises to 9 per cent.

(a) How much will Ian be willing to pay for the mortgage?

(b) What will happen to the value of Treasury bond futures contracts? Will the long or short position increase in value?

Jennifer McAfee recently received her university master’s degree and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Finn has approached her about a mortgage for a house he is building. The house will be completed in three months and he will need the mortgage at that time. Finn wants a 25-year, fixed-rate mortgage for the amount of £500,000 with monthly payments.
Jennifer has agreed to lend Finn the money in three months at the current market rate of 8 per cent.
Because Jennifer is just starting out, she does not have £500,000 available for the loan, so she approaches Ian MacDuff, the president of IM Insurance, about purchasing the mortgage from her in three months. Ian has agreed to purchase the mortgage in three months, but he is unwilling to set a price on the mortgage. Instead, he has agreed in writing to purchase the mortgage at the market rate in three months. There are Treasury bond futures contracts available for delivery in three months. A Treasury bond contract is for £100,000 in face value of Treasury bonds.