Financial Risk Manager Part 1

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.