Financial Risk Manager Part 1

Explanation

A teaser rate is a promotional interest rate offered by mortgage lenders for a specified initial period, typically the first few years of the mortgage term. This rate is significantly lower than the standard mortgage rate, making the mortgage appear more attractive to potential borrowers.

Key Characteristics:

• Low introductory rates: Offered for the first few years of the mortgage
• Significant rate increases: After the initial period, rates increase substantially
• Marketing tool: Used to attract new borrowers into the housing market
• Risk factor: Contributed to the Credit Crisis of 2007 when borrowers couldn't afford the higher payments after the introductory period

Why Other Options Are Incorrect:

• Choice A: While promotional materials may mention teaser rates, this definition is too vague and doesn't capture the key feature of low initial rates that increase significantly later.
• Choice C: This describes a standard adjustable-rate mortgage structure tied to LIBOR, not the specific promotional aspect of teaser rates.
• Choice D: This refers to mortgage restructuring terms for defaulting borrowers, which is unrelated to teaser rates.

During the Credit Crisis, teaser rates played a significant role as many borrowers who qualified for mortgages at the low introductory rates found themselves unable to make payments when rates reset to much higher levels, leading to widespread defaults.