Chapter 23, Problem 3M

Summary Introduction

Case summary:

This case discusses the circumstances that have to be encountered by a mortgage business broker. Person JC is a new mortgage business broker and her cousin MK has approached to have a mortgage for a house that is being built. The house construction has to be completed in three months and he needs the mortgage at the completion stage of the house. The requirement of person MK is 25-year, $400,000 fixed-rate mortgage to be repaid on a monthly basis.

Person JC has agreed to lend the money at the present market rate of 6%. Due to having insufficient fund with person JC, he has approached person IT, the president of IT Insurance Corporation for purchasing mortgage. Person IT has agreed the demand from person JC except on the price of the mortgage because he is unwilling to set a price on the mortgage loan, but rather he does agree in writing to purchase the mortgage at the market rate in three months. Moreover, the market has Treasury bond futures contract with a face value of $100,000 per contract at a maturity of three months.

Characters in the case:

• Person JC: Owner of the mortgage business
• Person MK: Customer of JC
• Person IT: President of IT Insurance Corporation
• Company IT: An insurance corporation

To determine: Hedging the interest rate risk of person JC