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MB Group Assignment

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15 views2 pages

MB Group Assignment

Uploaded by

Như Ý Pham
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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a) To calculate how much the bank is entitled to from the sale of the house when James dies at age

80, we first determine the total amount James receives from the reverse mortgage. He receives
$1,500 monthly for 15 years (from age 65 to 80), which totals $1,500 × 12 months × 15 years =
$270,000. The bank charges interest at a rate of 8.4% per annum compounded monthly. The total
amount due to the bank can be calculated using the formula for the future value of an annuity

The monthly interest rate is 8.4% / 12 = 0.007. The total amount due is calculated as follows:
Total amount due = P × [(1 + r)^{nt} - 1] / r
Where P = $1,500, r = 0.007, n = 12, and t = 15
Total amount due = $1,500 × [(1 + 0.007)^{12 × 15} - 1] / 0.007
Calculating this gives us approximately $1,500 × 224.99 = $337,485. Therefore, the total amount the
bank is entitled to from the sale of the house is $337,485

Answer: $337,485.

b) To calculate what is left for James's family after payment to the bank, we first need to determine
the future value of the house at the time of James's death. The house value increases at an average
rate of 1.5% per annum compounded monthly. The future value of the house can be calculated using
the formula for compound interest:
Future Value = Present Value × (1 + r)^{nt}
Where Present Value = $550,000, r = 0.015/12, n = 12, and t = 15
Future Value = $550,000 × (1 + 0.00125)^{12 × 15}
Calculating this gives us approximately $550,000 × 1.2507 = $688,885. The amount left for James's
family after paying the bank is $688,885 - $337,485 = $351,400

Answer: $351,400.

c) To determine the NPV and IRR for the bank from this reverse mortgage, we consider the cash
flows. The bank pays James $1,500 monthly for 15 years, totaling $270,000. The cash inflow occurs
when the house is sold after James's death. The bank's required return rate is 6% per annum
compounded monthly. The cash flow for the bank is negative for the first 180 months and then a
positive cash flow when the house is sold

The NPV can be calculated using the formula:


NPV = Σ (Cash Flow / (1 + r)^{t})
Where r = 0.06/12 and t is the month number. The cash inflow at month 180 is the amount due to
the bank ($337,485). The IRR is the rate that makes the NPV equal to zero

Calculating these values requires financial software or a financial calculator for precise results.
However, based on the cash flows, we can estimate that the NPV is positive, indicating profitability,
and the IRR is likely above the required return of 6%

Answer: NPV is positive; IRR is above 6%

d) Three risks that can adversely affect the bank's profitability include:

1. Market Risk: If the housing market declines, the value of the house may not cover the
amount owed to the bank, leading to losses

2. Longevity Risk: If borrowers live longer than expected, the bank may end up paying more in
monthly disbursements than anticipated, reducing profitability
3. Interest Rate Risk: Changes in interest rates can affect the bank's cost of funds and the
profitability of the reverse mortgage product

e) Redoing the calculations with varying factors:

1. If James dies at age 75, he receives $1,500 × 12 × 10 = $180,000. The amount due to the
bank would be calculated similarly, resulting in a lower amount owed, and the family would
receive more from the house sale

2. If James dies at age 85, he receives $1,500 × 12 × 20 = $360,000. The amount due to the
bank increases, potentially leaving less for the family

3. If the required rate of return is 4% or 8%, the NPV and IRR will vary accordingly, with a lower
rate resulting in higher NPV and IRR

4. If the house price drops by 0.5% or increases by 3.5%, the future value calculations will
change, affecting the amount left for the family

f) The advantages of reverse mortgages for the bank include a steady income stream from interest
payments and the potential for property appreciation. For customers, reverse mortgages provide
access to cash without selling their homes, allowing them to maintain their lifestyle. However,
disadvantages for the bank include risks associated with property value fluctuations and longevity of
borrowers. For customers, disadvantages include the potential for reduced inheritance for heirs and
the obligation to repay the loan upon death or relocation

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