An adjustable rate mortgage (ARM) loan is made for $150,000 for 20 years with the following terms:

Compounding frequency = monthly Initial interest rate = 4.5% per year Index = 1-year government bond rate Payments reset each year Margin = 2% Interest rate cap = none Payment cap = 20% increase in any year Discount points = 2%

Fully amortising loan, and negative amortisation is allowed if payment cap is reached

Based on estimated forward rates, the index (1-year government bond rate) to which the ARM is tied is forecast to be 5.5% at the beginning of year 2 (coinciding with the loan payment reset).

Based on the above information, calculate the following (answers should be to two decimal places):

1. Monthly mortgage payment amount in year 1. (10 marks)
2. Loan balance at the end of year 2. (10 marks)
3. Yield (or effective cost of borrowing) of the ARM for the first 2-year period of the loan. (10 marks)