P1.T3. Tuckman - Value of a mortgage

[Rolme]

Hi

I have difficulties understanding the following quote regarding the value of a (remaining) mortgage (p. 7 of reading 24):

"Therefore, in case of floating rate (non-fixed) mortgage loans, if rates or spreads rise after origination, the present value of the remaining mortgage payments will be worth less than the outstanding principal amount, whereas, if rates fall, this present value will exceed the outstanding principal amount."

I would assume that for a floating-rate mortgage loan, if rates rise after origination, payments would increase in line with higher rates?

The above quote would make sense to me for a fixed-rate mortgage loan where payments are fixed but present value of the sum of fixed payments reduces with higher rates (as they're more heavily discounted) and vice versa.

Can someone help me with this?

thanks,
Roland

 

[leomeister]

Hello,

I'm stuck here as well. I can understand this if the mortgage payments are fixed, then it's just that lower rates will make the present value of these fixed payments to increase. Are they fix in the floating rate case as well?

Best, Leo

 

[David Harper CFA FRM]

Hi @leomeister You are stuck for a good reason, I don't know how we've let this mistake persist. Sorry, but it doesn't make sense, you are correct. Embarrassing And Tuckman does not actually discuss floating rate mortgages at all in Chapter 20. We will re-issue this study note ASAP (cc @Nicole Seaman )

 

[surbhi.7310]

Hi Rolme

I dont know if I am thinking in the right direction but if the interest rate spread rises, hence the monthly payments increase, the outstanding principle will reduce more and hence its present value which was discounted previously at a lower fixed rate than the one at present will decrease.
@David Harper CFA FRM please correct me if I am wrong!

Regards
Surbhi