Problem: (Wraparound Loan) Consider the same old loan as in Question, only now suppose interest rates have risen instead of fallen, so that similar loans today would carry a 12% interest rate. Suppose further that the old loan has no due-on-sale clause, and you want to sell the property that is collateral on the loan. A buyer is willing to pay $10 million for the property, but has only $2 million available, and does not feel comfortable with the payments on an $8 million mortgage at 12%, although he would do the deal at 11.5% with a 30-year amortization rate and a five-year balloon.

a. What would be your yield on your investment in a wraparound loan meeting the seller's specifications?

b. Why are you able to get an expected return on this investment so much in excess of the current market rate of 12%?

Question: (Prepayment Option) Three years ago, you obtained a 10%, $6 million, monthly-payment mortgage with 20-year amortization and an eight-year maturity. (The loan thus matures five years from now, with a balloon payment.) This loan has a prepayment clause, but stipulates a three-point prepayment penalty on the outstanding balance. Today, it would be possible to obtain a similar mortgage at 8% interest with a one-point origination fee up front and 20-year amortization.

a. Assuming transaction costs would be $60,000, and the current value of the prepayment option in the old loan is $150,000, what is your NPV for paying off the old loan today?

b. If you could reduce the transaction costs to $50,000, should you pay the loan off immediately?