Final answer:
b) Margin
The margin is added to the index rate to determine the adjustable interest rate on an ARM. It remains constant, serving as a safeguard for lenders against the risk of inflation and to ensure a stable return on loans.
Step-by-step explanation:
To determine the applicable interest rate at the time of adjustment on an adjustable-rate mortgage (ARM), the margin is added to the index rate. Unlike the prime rate, which is a rate that banks charge their most creditworthy customers, or discount rate, which is the interest rate the Federal Reserve charges on loans to commercial banks, the margin is a set percentage that stays constant over the life of the loan. The index rate, on the other hand, is a benchmark interest rate to which the ARM is tied and can fluctuate with market conditions, ultimately affecting the interest rates on ARMs. If inflation rises, for instance, it can lead to higher index rates, prompting an increase in the interest rates charged on adjustable-rate mortgages to maintain the real interest rate the lender receives. The margin is designed as a safeguard for lenders against the risk of inflation and to ensure that they receive a stable return on their loans.