Florida International University
REE6200 Final Exam
Fall 2012
There are three questions in this exam. You may use the Excel templates discussed in the classes to complete these questions. You can make additional assumptions if you think they are necessary (please write them down in your exam). For those qualitative questions, please provide a brief answer. Please highlight every numerical answer to facilitate grading. Good Luck!
1. (30 pts) Lakeview Limited Partnership has been formed to acquire and operate an office building in Boston. For simplicity, assume that there are only 1 general partner and 1 limited partner. Based on the agreement of the partnership, equity contributions are: general partner, 0%, and limited partner, 100%. Cash distributions from operations: general partner, 10%, limited partner, 90%. Taxable income and losses from operations: general partner, 10%, limited partner, 90%. Allocation of gain or loss from sale: general partner, 15%, limited partner, 85%. Cash distribution at sale: based on capital account balance. Note:the partnership initially decides to use 100% equity finance.
Property capital structure: Amount
Purchase Price $24,000,000
Organization Fees (Amortized over two years) 500,000
Syndication Fees (included in the original cost) 500,000
Total $25,000,000
Less Mortgage Loan 0
Equity Requirement $25,000,000
Depreciable Basis:
Purchase Price $24,000,000
Land value (2,400,000)
Building Improvement $21,600,000
Depreciable Life (for the improvement) 39 years
Annual Depreciation $553,846
Tax Rate* 28%
Operational Year Year 1 Year 2
NOI at the end of year $2,000,000 $2,500,000
* Assume the tax rate for operational income and capital gains are the same.
The limited partnership is expected to sell the office building at the end of year 2 (Assume the partners make equity contributions at the beginning of year 1). The expected sales price is $30,000,000. Selling expenses will be 8% of the sales price.
a. What are the before tax cash flows from operation of the investment that would be distributed to the limited partner for year 1 and year 2? [5 pts]
b. How much capital gains would be allocated to the limited partner upon sale of the property? [5 pts]
c. What is the capital account balance for the limited partner after the two years? [5 pts]
d. What is the aftertax IRR on total funds invested in the property (ATIRR_{P}) [5 pts]
e. Determine an estimated aftertax equity return (ATIRR_{E}) for limited partner. [5 pts]
f. Suppose that a loan is available, with annual interest rate 8%, amortized over 25 years, and monthly compounded. The loan amount will be 80% of the initial purchase price. In this case, is there favorable financial leverage if the limited partnership borrows this loan? Why? [Hint: calculate the ATIRR_{E} given the loan is borrowed]. Briefly discuss. [5 pts]
2. (30 pts)A property is expected to produce the following income stream over the next three years:

Year 
NOI 

1 
$575,000 

2 
600,000 

3 
625,000 
A lender is willing to make a $6,000,000 participation mortgage, assuming annual payments, at 6% interest rate, a 30 year amortization period, with a balloon payment at the end of year 3. In addition, the lender gets 10 % of each year's net operating income and 20% of the net sales proceeds (i.e., the sales proceeds minus the selling expenses and then minus the mortgage balance). The purchase price of the property is $8 million. The investor of the property expects to sell the property for $9 million at the end of the third year with the selling expenses of 5.5% (of the sales price).
a) 
Calculate the beforetax mortgage yield for the loan, assuming that the loan is held for 3 years. (10 pts) 
b) 
What is lender’s beforetax mortgage yield if the property ends up with selling for $8million at the end of the third year, instead of selling for $9 million? (10 pts) 
c) 
Why do lenders and borrowers prefer a participation loan? What are the benefits and the risks associated with this type of loans? Briefly discuss. (10 pts) 
3. (40 pts) Bank of America issues a MBS security based on a mortgage pool with the following terms:
Mortgage pool value $25,000,000
Mortgage interest rate 6.5%
Loan Term 3 years
a) Suppose that the MBS has only one class of security, i.e., the basic MBS discussed during the class. What is the price of this MBS if the market interest rate is 5.75%? Assume annual compounding as well as a constant annual prepayment rate of 10% (based on the outstanding loan amount at the beginning of each year, the same as the case we discussed during the class). (10 pts)
b) Why is MBS considered a “callable” bond? How can this callable feature affect MBS pricing? Briefly discuss. (10 pts)
Now, another investment bank suggests that, instead of creating the singleclass MBS security as above, two classes of securities can be created based on the same mortgage pool, i.e., an IO and a PO security.
c) Determine the price of the IO and PO security, assuming that there is no prepayment. Further assume that the IO investors require a market rate of return of 4.5% and the PO investors require a market return of 6%. (10 pts)
d) Now suppose future interest rates will fall, so there is a 10% prepayment for each year (prepayment calculation is based on the loan balance at the beginning of the year). The IO and PO investors require a market rate of return of 4% and 5.5%, respectively. Determine the prices of the IO and the PO security. (10 pts)
A+++++++++