Suppose a mid-sized regional bank has $1 million dollars which it is considering investing either in 30 year zero coupon Treasury bonds or in a jumbo 30 year fixed rate residential mortgage with fixed monthly payments of $5650.Assume that the treasury bonds are currently priced to yield 4% if held until maturity. Assume that the bank requires a premium of 150 basis points in the mortgage`s annualized yield over treasury bond yields before it will lend in the residential mortgage market.
A) Write down the present value equations that the bank would use to determined the annualized percentage rate of return on the residential mortgage. (Wherever possible, plug data from the above problem into the equations.
B) How will the bank use the information on the annualized percentage rate of mortgage obtained in part (a) when deciding whether to invest in T-Bonds or whether to make the residential mortgage?