An embedded option associated with the following instrument potentially alters the rate sensitivity of the underlying instrument.

Fixed-rate mortgage loan with a yield of 5.5 percent and 30-year final maturity.

The option is typically exercised when interest rates _____ substantially. It is the ____that determines when the option is exercised.

X	A.	increase; bank
	B.	decrease; bank
	C.	increase; banks customer
	D.	decrease; banks customer

(continue from problem 1)

An existing fixed-rate mortgage is ____ rate sensitive in a ____ rate environment.

	A.	more; rising
X	B.	more; falling
	C.	less; falling

(continue from problem 1)

Does the exercise of the option affect NII? If yes, will it _____ banks net interest income.

	A.	No
X	B.	Yes; increase
	C.	Yes; decrease