Financial Risk Manager Part 1
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In the early 2000s, mortgage lenders introduced a new strategy to attract more customers by offering adjustable mortgage rates with initial 'teaser rates'. This strategy involved a lower interest rate for the first few years, followed by a significantly higher rate in the subsequent years. What was the immediate impact of this strategy on the mortgage market?
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A
Tighter lending standards, making it more difficult for potential homeowners to secure a mortgage.
B
The number of mortgage applications started to increase.
C
The price of houses started to rise.
D
A rapid increase in mortgage defaults.
Explanation:
Explanation
The correct answer is B - The number of mortgage applications started to increase.
Why this is correct:
- Mortgage lenders in the United States started to relax lending standards around 2000
- The adjustable mortgage rates with initial 'teaser rates' offered lower interest rates for the first 2-3 years, making mortgages more affordable
- This strategy immediately increased demand for homes as families who were previously unqualified could now afford to repay borrowed funds
- The immediate effect was an upturn in mortgage applications, not tighter standards or price increases
Why other options are incorrect:
A is incorrect - The introduction of adjustable mortgage rates with 'teaser rates' actually represented a relaxation of lending standards, not tightening. This strategy aimed to make mortgages more accessible.
C is incorrect - While the strategy did lead to increased demand for homes, it did not immediately cause house prices to rise. The primary immediate effect was increased mortgage applications.
D is incorrect - The rapid increase in mortgage defaults occurred later, when the 'teaser rates' ended and higher rates were applied that many homeowners couldn't afford. This was not the immediate impact.
Key Risk Management Insight:
This case demonstrates how risk management strategies can have unintended consequences. Lenders viewed this as low-risk due to continually increasing home prices providing collateral protection, but this assumption proved flawed when market conditions changed.
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