Problem:

Houses in an area have been appreciating at the rate of 4 percent a year. An investor expects to finance a home purchase with a loan-to-value ratio of 80 percent.

Required:

Question 1: What is the expected appreciation rate on home equity (EAHE) for the first year? Show all work.

Question 2: What if the expected rate of appreciation in the house price for the second year (year 2) is 2% and for year 3 is 5%. What is the average rate of appreciation in home equity over the 3-year period? Calculate both an arithmetic and geometric average. Show all work.