CMPS Financial and Housing Markets 2 — Questions and Answers
Question 1: When the Federal Reserve increases the federal funds rate, what typically happens to long-term mortgage rates?
- They decrease immediately
- They generally rise over time (Correct answer)
- They are unaffected because mortgages use different benchmarks
- They only change for adjustable-rate mortgages
Correct answer: They generally rise over time
Rising federal funds rates push up borrowing costs across the economy, which generally causes long-term mortgage rates to increase as well.
Question 2: What does a steepening yield curve typically signal about the economy?
- Recession is imminent
- Investors expect stronger future growth and potential inflation (Correct answer)
- Short-term rates are rising faster than long-term rates
- The housing market is declining
Correct answer: Investors expect stronger future growth and potential inflation
A steepening yield curve — where long-term rates rise relative to short-term rates — generally reflects market expectations of stronger economic growth and higher inflation ahead.
Question 3: Which index is most commonly used as the benchmark for 5/1 adjustable-rate mortgages in the U.S.?
- Prime Rate
- LIBOR
- SOFR (Secured Overnight Financing Rate) (Correct answer)
- Treasury Constant Maturity Rate (CMT)
Correct answer: SOFR (Secured Overnight Financing Rate)
Since LIBOR's phase-out, SOFR has become the primary benchmark index used for adjustable-rate mortgages in the United States.
Question 4: A borrower's home value drops 15% after purchase with a 10% down payment. What is their approximate current loan-to-value ratio?
- 90%
- 100%
- 106% (Correct answer)
- 115%
Correct answer: 106%
With 10% down on, say, a $200,000 home, the loan is $180,000; if value drops 15% to $170,000, LTV = $180,000/$170,000 ≈ 106% (underwater).
Question 5: What is the primary purpose of Fannie Mae and Freddie Mac in the housing finance system?
- To originate mortgage loans directly to consumers
- To insure loans against borrower default
- To purchase mortgages and create mortgage-backed securities, providing liquidity (Correct answer)
- To set maximum conforming loan limits for all states
Correct answer: To purchase mortgages and create mortgage-backed securities, providing liquidity
Fannie Mae and Freddie Mac operate in the secondary market by purchasing loans from lenders, packaging them into MBS, and thereby replenishing lender capital to make more loans.
Question 6: Which economic indicator most directly measures construction activity in the new housing market?
- Existing Home Sales
- Housing Starts (Correct answer)
- Case-Shiller Home Price Index
- Mortgage Delinquency Rate
Correct answer: Housing Starts
Housing Starts measures the number of new residential construction projects begun during a given period, directly reflecting new-construction activity.
Question 7: How does rising consumer price inflation (CPI) typically affect fixed-rate mortgage demand?
- It increases demand as buyers rush to lock in rates before further increases (Correct answer)
- It reduces demand because purchasing power falls and rates rise
- It has no measurable effect on mortgage demand
- It only affects demand for jumbo loans
Correct answer: It increases demand as buyers rush to lock in rates before further increases
When inflation signals rising interest rates ahead, buyers often rush to lock in current fixed rates, temporarily increasing mortgage demand.
CMPS Financial and Housing Markets 2
When the Federal Reserve increases the federal funds rate, what typically happens to long-term mortgage rates?