ARMs were designed to transfer which type of risk?

Adjustable Rate Mortgages (ARMs) were designed to transfer interest rate risk from the lender to the borrower. In an ARM, the interest rate is not fixed for the entire life of the loan but instead adjusts periodically based on a specific index. This means that as interest rates in the market fluctuate, the borrower’s mortgage rate can also increase or decrease accordingly.

This design allows lenders to manage their exposure to changes in the market interest rates, while borrowers take on the risk of potential rate increases. If market rates rise, the borrower's payments may also rise, leading to the possibility of higher housing costs. Conversely, if rates fall, the borrower's payments might decrease, providing a potential benefit. Thus, ARMs inherently include a mechanism for transferring the risk associated with interest rate fluctuations to the borrower, making it clear why interest rate risk is linked to the function of ARMs.