If Rimsa maintains the mortgage on the office building purchased by Carson Company, what is the ultimate source of the money that was provided

If Rimsa maintains the mortgage on the office building purchased by Carson Company, what is the ultimate source of the money that was provided

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July 20, 2021
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Market Participation by Savings Institutions

Rimsa Savings is a savings institution that provided Carson Company with a mortgage for its office building. Rimsa recently offered to refinance the mortgage if Carson Company will change to a fixed-rate loan from an adjustable-rate loan.

a. Explain the interaction between Carson Company and Rimsa Savings.

Market Participation by Savings Institutions

Rimsa Savings is a savings institution that provided Carson Company with a mortgage for its office building. Rimsa recently offered to refinance the mortgage if Carson Company will change to a fixed-rate loan from an adjustable-rate loan.

b. Why is Rimsa willing to allow Carson Company to transfer its interest rate risk to Rimsa? (Assume that there is an upward-sloping yield curve.)

Market Participation by Savings Institutions

Rimsa Savings is a savings institution that provided Carson Company with a mortgage for its office building. Rimsa recently offered to refinance the mortgage if Carson Company will change to a fixed-rate loan from an adjustable-rate loan.

c. If Rimsa maintains the mortgage on the office building purchased by Carson Company, what is the ultimate source of the money that was provided for the office building? If Rimsa sells the mortgage in the secondary market to a pension fund, what is the source that is essentially financing the office building? Why would a pension fund be willing to purchase this mortgage in the secondary market?

Answer and ExplanationSolution by a verified expert

part a

Here is a tip:
Savings institutions include saving banks and savings and loan associations, where the latter is the dominant type.

Sample Response
Company C can benefit from R savings institutions because they have access to the funds which is required for paying for the office building. Saving institutions R gets the fund from depositors and benefits from channelizing those funds to company C because they charge a greater interest rate on the loans that they pay on the deposits. The spread also covers non-interest expenses that have been incurred.

part b
Here is a tip:
The yield curve becomes upward sloping when there is an increase in the time to maturity with respect to the interest rates.

Sample Response
Savings institution R makes an offer to provide a fixed-rate loan because there is an increase in the actual spread on the loan. Savings institution R might not expect an increase in the interest rate and therefore, it will be benefitted from the conversion to a fixed-rate loan. On the contrary, savings institution R can hedge the interest rate risk with the interest rate futures contract or interest rate swaps. Generally speaking, savings institutions might be highly capable than the other non-financial firms in hedging their interest rate risk.

part c
Here is a tip:
Pension funds can use their maximum time for focusing on making good investments.

Sample Response
When the savings institution R maintains the mortgage, their depository provides the money. When savings institution R sells their mortgages to the pension funds, money is provided by the employees and employers of the fund. The pension funds are benefitted from the mortgage because the mortgage generates interest as well as principal payments for their participants.

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