Financial Risk Manager Part 1

Explanation

Correct Answer: C - Nonrecourse mortgage

A nonrecourse mortgage is a type of loan where the lender can only seize the borrower's home (the collateralized property) in the event of default, but cannot pursue the borrower's other assets. This feature provides borrowers with protection by limiting the lender's recourse to only the specific property securing the loan.

Key Features of Nonrecourse Mortgages:

• Lender's recovery is limited to the collateral property only
• Borrower's other personal assets are protected from seizure
• Essentially provides the borrower with an American-style put option on their home
• If housing prices fall, the borrower can effectively "sell" their home to the lender for the outstanding mortgage principal

Why Other Options Are Incorrect:

A. Teaser Rate - This refers to an initial low interest rate on a mortgage that's temporarily lower than the eventual standard rate. It's a pricing feature, not related to asset seizure in default.

B. NINJA Borrowing - Stands for "No Income, No Job or Assets" - a risky lending practice where borrowers don't need to provide proof of income, job, or assets. This relates to underwriting standards, not asset seizure limitations.

D. Securitization - Involves pooling various types of contractual debt (like mortgages) and selling the related cash flows to investors as securities. This is a financing mechanism, not a feature related to asset seizure limitations in default.

Nonrecourse mortgages are particularly common in certain U.S. states and provide significant protection to borrowers by limiting their liability to the collateral property only.