Office mortgage:-
A young engineers consulting firm has done well. and the owner wants to purchase new office space for the firm and as a real estate investment. Shopping around, the engineer has found three financing options for the mortgage. A variable-rate mortgage is available that uses a market-sensitive;-index. The index closely follows current market interest rates.
If interest rates go up. the engineer would have t~ pay higher interest on the mortgage, based on the S-index. Of course . if interest rates go down, the engineer would pay less interest, again based on the S-index.
Another variable-rate mortgage is available that uses a Jagged .. L"-index. Since this index includes a multiperiod lag, it is not as sensitive to current market interest rates, and changes more slowly.
Finally, a fixed-rate mortgage is available which sets the interest rate at the current market fixed rate. Fixed rates are usually initially higher than variable rates. The engineer estimates the payoff matrix shown in the table below. where numbers represent annual interest rate savings.
|
|
Future interest Rates
|
|
|
Up
|
Dom
|
Same
|
|
S-index
|
-3
|
3
|
1
|
|
L-index
|
-2
|
2
|
1
|
|
Fixed
|
0
|
0
|
0
|
Check for dominance and determine the best action to take using the following criteria.
(a) Laplace
(b) Hurwicz(show graph)
(c) maximin
(d) minimax regret
(e) maximax