What is meant by “redeem up, foreclose down”?

An exculpatory clause exempts the mortgagor from personal liability on a mortgage,Other things being equal, would you expect a lender to demand a higher or lower interest rate on creating a non-recourse mortgage.

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What is the relationship between a borrower’s limited liability and the value of a borrower’s put option?

Consider a non-recourse mortgage with one payment of $10,600,000 due one year from now.

The uncertain future is characterized by the following scenarios and probabilities:


Scenario I: 70% probability, property worth $13,000
Scenario II: 20% probability , property worth $11,000
Scenario III: 10% probability, property worth $9,000,000

If foreclosure occurs, the (deadweight) cost paid to third parties will be $2,000,000.

One-year US Treasuries are yielding 6% and investors require a risk premium of 1%.

a.[2pts] What is strategic default, and how is it related to limited liability and the cost of foreclosure?

b. [10pts] What would this loan sell for today if scenario III results in a deed-in-lieu, and scenario II results in a strategic default in which the difference between the borrower’s and lender’s extreme position is split 50/50?

c.[2pts] What is the present value cost of credit risk?


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