6.2. ARM. Suppose that you are considering an ARM with the following characteristics

Mortgage Amount = $120,000 Index = One-year TB Yield Margin = 2.50 Annual Interest Rate Cap = 2% Lifetime Interest Rate Cap = 5% Discount Points = 2 Loan Maturity = 30 Years

A) If the TB yield is currently 6%, what is the monthly payment for the first year? (Assume that that loan is fully indexed at the outset.)

B) If the index moves to 7.5% at the end of the first year, what is the payment for year 2?

C) If the loan is completely repaid at the end of year 2, what is the effective yield? D) Suppose that, beginning in year two, the index remains at 7.5%. What is the APR on the loan?

A)

i₁ = 6.0+2.5 = Pmt1 = 120,000 (MC8.5,30) = $922.70

Keystrokes

-120,000 PV

8.5 I/Y 360 N

PMT

B)

BalEOY₁ = $119,093

Keystrokes

922.70 PMT

8.5 I/Y

348 N

PV

i2 = 7.5+2.5 = 10%

Pmt2 = 119,093 (MC10,29) = $1,050.97

C) 120,000 - 2400 = 922.70 (PVAFi/12,12) + 1,050.97 (PVAFi/12,12) (PVFi/12,12)

+ 118,357 (PVFi/12,24)

i = 10.33%

Keystrokes (Cash Flows BAII plus)

CF_o = (117,600)

CF₁ = 922.70 F₁= 12

CF₂ = 1050.97 F₂= 11

CF₃ = 119,329 (118357 + 1050.97) F₃= 1

my questions are as following:

Part A. why does the index equal 8.5%? I understand it's the index + the margin but the interest cap is 2 so shouldn't it only be 8%?

Part C. I don't understand why CFo = 117,600.

- on the left side of the equation (part C) where it shows 120,000 - 2,400 im confused on how you get 2,400 because I cant figure it out.