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Keywords = capped adjustable rate mortgages

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10 pages, 746 KiB  
Article
What Should You Pay to Cap your ARM?—A Note on Capped Adjustable Rate Mortgages
by Maj-Britt Nordfang
Int. J. Financial Stud. 2017, 5(1), 10; https://doi.org/10.3390/ijfs5010010 - 6 Mar 2017
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Abstract
In this paper, an Adjustable Rate Mortgage (ARM) and a Fixed Rate Mortgage (FRM) are formalized and studied in a simple continuous-time setting under the assumption of a simple one-factor Affine Term Structure (ATS). Through an application of existing results from ATS theory, [...] Read more.
In this paper, an Adjustable Rate Mortgage (ARM) and a Fixed Rate Mortgage (FRM) are formalized and studied in a simple continuous-time setting under the assumption of a simple one-factor Affine Term Structure (ATS). Through an application of existing results from ATS theory, it is shown that when the short rate reaches a certain pre-determined boundary, the constant payment stream on a new FRM equals the payments on an existing ARM. Hereby, this paper provides a theoretical build-in cap on the formalized ARM. The finite boundary for the short-rate suggests that certain caps on ARMs should (in theory) be offered free of charge. Full article
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