Introduction to Finance
Requirements:
1. The submission must be a Word file. The file name must be in the format like last name- first name-term-project.docx.
2. Have a cover page to list the course name, term, and each team member’s name.
3. Maximum length: 10 pages; double spaced;
4. Provide references you used in the term paper;
5. Use tables or figures to show your results;
6. Consult with a real estate agent about the purchase (optional); if this is applicable, discuss your experience in the report;
7. All the calculations, such as mortgage payment, NPV, etc., in this project must be done by you using Excel or a calculator. Using a template online to get the result is not allowed.
Today’s low interest rates in the USA offer an opportunity to get a low-cost mortgage. The low interest explains why U.S. housing prices have not declined but increased during the global pandemic
– see the price move inside the circle of the S&P/Case-Shiller U.S. National Home Price Index in 2020.
You are deciding to purchase an investment property in an ideal location you prefer. You would address the following issues before buying the property :
1) Decide the location and the specific real estate property you would like to buy (e.g., a single-family house or a condo). Provide justification why the property is chosen, e.g., affordability, the potential of price appreciation. Use some data to justify your selection, e.g., the housing price growth rate in the region.
You could use the resource like zillow.com, etc.
2) Find out the mortgage rates for different properties and choose between 30 or 15-year fixed-rate mortgage (FRM). You could use bankrate.com, etc. Justify your decision.
3) Calculate the monthly mortgage payment given the down payment (20% of the price) you will make. This will be a fixed 80% payment mortgage loan with 20% down payment. It means you will pay 20% down payment at the purchase and finance 80% with the mortgage. Show your calculations of monthly mortgage payments in the report.
4) In the meantime, predict the amount of monthly rental you will be able to collect when you lease the property out (zillow.com also provides rental price information). The rental period is the same as your mortgage period. In other words, you will pay off your mortgage and end the rental in the same year. Justify your rental income projection.
5) Project the resale value of the property at the end of the mortgage payment period. You need to use some statistics to back up your numbers.
6) Once you have
a. the projected monthly mortgage payment
b. the monthly rental income
c. the resale value of the property at the end of the mortgage payment period
You could calculate the net present value (NPV) of the cash flow in a, b, and c, respectively. The present value could be calculated in Excel or using a financial calculator. The discount rate is the mortgage rate. The return on your investment property is calculated as return = (Sum of NPV in a, b, and c/ the down payment)
– 1. Show your calculation in the report.
7) Next, assume you don’t purchase an investment property. Instead, you invest the same amount of money as your total investment in the house in stocks (for example, investing in the S&P500 index or other indexes). You could use the average of 15 or 30 years of historical data of the S&P500 index to calculate the index return, a.k.a. use the yearly S&P 500 before the current year to calculate the yearly returns and average them.
The period of the expected index return is the same as your mortgage period, but the index data is backward. For example, if the mortgage period is 30 years, use the last 30 years of the index data to calculate the average stock return. Ignore all the expected dividends in the calculation. S&P500 index could be found in Yahoo Finance, wsj.com, or other financial resources.
8) Then assume you buy long-term treasury bonds with the same amount of money as your investment in the house. The period of the expected bond return is the same as your mortgage period. (e.g., if the mortgage is a 30-year mortgage, buy a 30-year Treasury bond). Find the YTM of the Treasury bond.
YTM is yield to maturity which is the annual return to the bonds. You could use the resource like wsj.com, etc. If there is no yield of the 15-year bond, use the yield of the 30-year bond and 10-year bond to extrapolate it.
9) Compare the return of the investment on your investment property, stock index, and Treasury bond. Explain the under-or out-performance of your real estate investment compared to the other two investments. Justify your conclusion.
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