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asdasdfas Flashcards

1
Q

Primary vs secondary market

A

Primary markets:
Securities INITIALLY ISSUED and sold by CORPS to RAISE FUNDS (like IPO)

Secondary markets, on the other hand, are where previously issued securities are traded among investors

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2
Q

Money market (bank loan) vs capital markets, difference

A
  • low risk low reward vs high risk high reward.
  • Bank heavily regulated

1) A regular bank is not securitized

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3
Q
  • Exchange vs over-the-counter (OTC) markets
A

Exchange markets: regulated, intermediate

OTC: P2P

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4
Q

Types of financial markets (ALL):

A
  1. Money Market /Bank loan market
  2. Capital Market
    a) Primary market (issued)
    b) Secondary market (retail)
  3. Exchange markets (intermediate; NYSE, regulated)
  4. Over-the-counter markets (P2P)
  5. Depository vs Non-Depository institutions
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5
Q

Types of financial institutions:

A

Depository Institutions:
Regulated and insured by government. Accept deposits
• Commercial banks
• Credit unions

Non-Depository
Not deposits, but other services
• Investment banks

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6
Q

Different Banking Risks

A

a) Credit Risk: Risk of non-payment from loans and securities.
b) Interest Rate Risk: Risk due to mismatched maturities of assets and liabilities.
c) Liquidity Risk: Risk of sudden liability withdrawals forcing asset liquidation at less than fair market prices.
d) Foreign Exchange (FX) Risk: Risk due to exchange rate changes affecting non-domestic asset values and liabilities.
e) Market Risk: Risk from changes in interest rates, exchange rates, and other prices.
f) Off-Balance-Sheet Risk: Risk due to contingent assets and liabilities held off the balance sheet.
g) Technology and Operational Risk: Risk from technological investments not producing anticipated cost savings or existing systems malfunctioning.
h) Fintech Risk: Risk of disruption from Fintech firms leading to lost customers and revenue.
i) Insolvency Risk: Risk of not having enough capital to offset a sudden decline in asset value.

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7
Q

What is Risk Management in Banking

A

Asset Liability Management (ALM) is a process to manage a bank’s balance between assets and liabilities to minimize financial risk and maximize profitability. This includes managing interest risk, liquidity risk, currency risk, and credit risk.

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8
Q

What are the main types of debt markets?

A

There are two main types of markets where firms can get external finance: bank loan markets and capital markets.

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9
Q

Difference of bank loan markets and capital markets

A
  • Capital markets involve buying and selling of equity and debt instruments, including primary and secondary markets.
  • Bank loans and bonds often include covenants, terms that ensure the borrower’s actions remain aligned with the lender’s interests throughout the loan tenure.
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10
Q

Advantages and disadvantages of Debt as a funding source

A
  • Debt Advantages: Retains ownership, less influenced by market swings, and is easier to raise.
  • Debt Disadvantages: Legal obligation to repay, and lenders may claim on assets during bankruptcy.
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11
Q

Advantages and disadvantages of equity as a funding source

A
  • Equity Advantages: No legal obligation to repay, and no claims on assets during bankruptcy.
  • Equity Disadvantages: Dilutes ownership, potential for shareholder activism, potential for hostile investors, and voting rights may be affected.
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12
Q

Why do banks exist? The different perspectives

A
  1. The Transaction Cost Perspective
  2. Information Creation through Screening and Monitoring
  3. Diversification and Risk Sharing:
  4. Asset Transformation and Risk Management:
  5. Liquidity Creation
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13
Q

Why Banks Exist: The Transaction Cost Perspective

A

Banks exist mainly to reduce transaction costs.

  1. Direct and observable: Traveling, searching
  2. Indirect and unobservable: Agency costs or information costs
  • Expertise
  • Information economies of scope
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14
Q

Why Banks Exist: Information Creation

A

• Banks mitigate agency problems caused by imperfect information.
1. Screening (identifying borrower risk)
2. Monitoring (tracking borrower actions post-loan)

  • Invest in new tech
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15
Q

Why Banks Exists: Diversification and Risk Sharing:

A

• Banks pool resources from many depositors and lend to a diversified portfolio of borrowers, which spreads out the risk.

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16
Q

Why Banks Exists: Asset Transformation and Risk Management

A

• Banks convert short-term deposits into long-term loans, managing the risk difference between the two.
• Bank use Asset-Liability Management (ALM) to match assets and liabilities + collateral

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17
Q

Whats Asset-Liability Management (ALM) for, and what are the tools?

A
  • Banks use Asset-Liability Management (ALM) to manage risks with the goal of matching assets and liabilities maturities and cash flows.

1) Market Risk Models (manage risk from market conditions, like market prices and volatilities)

2) Interest Rate Risk Models (analyze changes in interest rates)

3) Liquidity Risk Models (Manage risk with funding and cash flow availability)

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18
Q

Why Banks Exists: Liquidity creation:

A

• From the big pool, banks can covert illiquid assets (loans) into more liquid assets (deposits)
• I can withdraw cash even with a big loan

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19
Q

Financial Innovation Definition

A
  • Financial innovation involves creating and popularizing new financial instruments, technologies, institutions, and markets.
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20
Q

Benefits of Financial Innovation

A
  • Benefits include reduced transaction costs, more complete financial markets, and potential tax and regulatory arbitrage.
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21
Q

Good financial innovations and Bad

A

BAD:
1. Collateralized Debt Obligations (CDO)
2. Special Purpose Vehicles (SPVs) / Structured Investment Vehicles (SIVs)
3. Credit Default Swaps (CDSs)

Good:
ATMs, credit cards, basic forms of securitization, and crowdfunding

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22
Q

Securitized products – ABS

A
  • An asset-backed security (ABS) is a security collateralized by cash flows from assets, usually those generating cash flows from debt.
  • eg. student loans
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23
Q

Securitization: How Mortgages to Securities – MBS is converted

A
  • Securitization converts mortgages into Mortgage-Backed Securities (MBS), giving investors access to mortgage loans.
  • An SPV (Special Purpose Vehicle) is created to securitize assets, making the process somewhat long and complicated.
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24
Q

Why Securitization from Banks’ Perspective

A

Liquidity & Transfer risk
1. Liquidity: Can convert illiquid assets (like mortgages) into cash quickly, improving their liquidity status.
2. Risk Management: Can transfer risk associated with the loans to investors

  1. Other: Move assets Off-Balance Sheet, so reduce their capital requirements
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25
Q

Benefits of Securitization

A
  • It brings financial markets and capital markets together.
  • It results in structured financial instruments that align more closely with investor needs.
  • It allows certain investors to participate in assets they otherwise couldn’t.
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26
Q

Monitoring Borrowers After Securitization - problem

A
  1. Banks sell the securitized packages to investors, so they no longer bear the majority of the risk
  2. Can lead to loosened incentive for banks to maintain strict oversight
    a) Poor underwriting (approve loans that otherwise would have gotten rejected)
    b) Failure to monitor borrower (have less incentive to do so)
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27
Q

Credit Default Swap (CDS)

A

Allows investor to protect against the risk of default on a particular debt security.

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28
Q

Benefits of CDS

A

Protection & Distribution of Risk

  • Individual: Protect against risk
  • System: CDS distribute risk widely throughout the system, prevent large concentrations of risk, and provide important information about credit conditions.
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29
Q

The Dark Side of CDS

A

A owns bonds issued by company XYZ

  1. A is concerned about default and buys CDS from Investor B on XYZ
    • A is paying premium to B
    • Consequence: A stops monitoring XYZ
  2. XYZ starts getting troubled
    • A does not do anything, assume that he is protected
  3. XYZ goes bankrupt
    • B have financial trouble, cannot pay A
    • A is very much exposed to losses
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30
Q

Government Intervention after 2008

A

The U.S. Government’s TARP program provided liquidity and equity injections into the financial market

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31
Q

Regulations in the Aftermath of 2008

A

Basel II.5
Basel III
Dodd-Frank
EU regulation, etc.,

capital requirements & liquidity & restrictions:

to increase banks’ capital requirements, improve liquidity, and enforce restrictions on certain trading activities.

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32
Q

Iceland’s Financial Crisis:

A
  1. Iceland’s banks offered high interest rates
  2. This gave high value for the krona
  3. When the 2008 crisis occurred, the banks defaulted on their foreign debt, causing the krona’s value and the stock market to plummet
  4. The banks were too big to be saved by the Icelandic government, leading to a bailout negotiation with the International Monetary Fund (IMF)
  5. Iceland’s economic collapse had impact on rest of Europe
33
Q

What was unusal about Lehman Bankrun

A

The Lehman Brothers bank run in 2008 wasn’t a traditional bank run as it was mostly institutional investors who withdrew their short-term funding due to liquidity problems.

34
Q

Run on Reop 07-08

A

The panic of 2007-2008 was a run on the sale and repurchase market (repo market), a significant short-term market providing financing for a range of securitization activities and financial institutions.

35
Q

Stopping a bank run, tools

A
  1. Suspension of Convertibility
  2. Coalition of Private Banks
  3. Government Deposit Insurance
  4. Capital Requirement and Cash Requirement
  5. Lender of Last Resors
  6. Goverment Bailouts
36
Q
  1. Suspension of Convertibility
A

: This method involves closing banks and refusing further withdrawals. While it can prevent immediate bankruptcy, it can also lead to panic in the financial system and limit access to cash for households.

37
Q
  1. Coalition of Private Banks
A

: Historically, private bank coalitions issued clearing house loan certificates during panics, acting as a form of deposit insurance. This method has its limitations, especially when all banks face a common shock.

38
Q
  1. Government Deposit Insurance
A

Central banks emerged as a response to banks’ inability to cope with panics. Despite some potential problems such as increased risk-taking by banks and the too-big-to-fail issue, deposit insurance is a prevalent measure.

39
Q
  1. Capital and Cash Requirement
A

These regulations ensure that banks hold sufficient capital relative to the risk they assume and maintain a minimum fraction of customer deposits as reserves. However, these can increase the cost of credit for the economy.

40
Q

Bank Regulation - The General Principles

A
  1. Licensing and Supervision (banks need banking license from regulator. Regulator supervises with requirements)
  2. Minimum Requirements (requirements, often linked to risk exposure)
  3. Market Dicipline (require bank to publicly disclouse financial information etc)
41
Q

Bank Regulation - Instruments and Requirements

A
  1. Capital Requirement (how they must handle capital in relation to assets)
  2. Reserve Requirement
  3. Corporate Governance (maintain a close watch on all operations)
  4. Financial reporting and discousre requirements
  5. Credit Rating Requirement (obtain and maintain a current credit rating)
  6. Large exposures restrictions. (restricted from being to exposed to one thing)
  7. Activity and Affiliation restrictions (banks cannot be to much affiliated to eg. security firms)
42
Q

Basel after 2008

A

Basel III (2010) updated the framework in response to the 2007-09 financial crisis. It emphasized the importance of maintaining a minimum Common Equity Tier 1 (CET1) ratio of 4.5% at all times.

43
Q

Hashing and Encryption

A
  1. Hashing transforms the message into a fixed-length string, making it easy to check for tampering in message
  2. Encryption, often confused with hashing, has a different purpose. While both transform data into a different format, encryption ensures data confidentiality and security, while hashing validates the integrity and uniqueness of the information.
  3. A digital signature, created by hashing the message and then encrypting it with the sender’s private key, is sent along with the message. The receiver can then decrypt the signature with the sender’s public key and verify its integrity.
44
Q

Forks of Bitcoin

A
  • Three possible scenarios are temporary, soft, and hard forks.
45
Q

Explain how FinTech has risen

A
  • It has been facilitated by technological advances
  • They make use of big data and automation to offer third-party services like digital payments, credit insurance, and wealth management.
46
Q

How Fintech Companies Create Value:

A
  • Reducing financial frictions and unit costs via vertical integration, automation, scale.
  • Mitigating adverse selections and reducing lending risks through more data and better modeling.
  • Aligning incentives of service providers and consumers to avoid moral hazard and agency conflicts.
  • Reducing search costs by easily matching service providers with customers.
  • Offering more tailored and convenient financial services.
  • Facilitating financial inclusion and helping address behavioral biases.
47
Q
  1. Challenges to Banks from Fintechs:
A
  • Fintech can transfer, raise, and invest money more efficiently, posing competition to traditional banking.
48
Q

Examples of Technology-Based Business Models:

A
  1. Platform-based business models,
  2. SaaS (Software as a Service),
  3. Data-driven models.
49
Q

Platform-Based Business Models

A
  • Businesses that facilitate interactions between two or more groups through a digital platform.
  • Platform owner creates value by enabling interactions, taking a commission or fee per transaction.
  • Types: Two-Sided Platforms (Ex: Vipps, Paypal, Airbnb, Uber), Marketplaces (Ex: LendingClub, Kickstarter, Etsy, Amazon, Alibaba).
50
Q

The traditional models of financingg

A
  • Peer-to-peer Finance Model
  • Financial Markets Model
  • Financial Intermediation Model
51
Q

what is crowdfunding and its differerent types?

A
  • Crowdfunding is raising capital from a large number of people through small investments or donations, typically facilitated by online platforms.

1) Reward- and Donation-based Crowdfunding,
2) Debt-based Crowdfunding,
3) Equity-based Crowdfunding,
4) Initial Coin Offerings (ICOs).

52
Q

Reward- and Donation-based Crowdfunding. Definition, pros and Example.

A
  • NON-FINANCIAL reward in return
  • Benefits:
    1. Understand demand: The people who contribute to the campaign are essentially doing it in support of the idea. The number of backers overall gives the entrepreneur an indication of market demand for their gadget.
    2. Visibility
    3. Extra source of financing
  • Example: Kickstarter, a platform that helps tech and creative entrepreneurs fund their projects.
53
Q
  1. Equity-based Crowdfunding: Definition, Pros and Cons, Regulation
A
  • This type of crowdfunding helps small businesses or early-stage startups raise capital by offering a small amount of equity in the company to individuals.

Pros:
1. Understand demand
2. Crowd-Wisdom (collect wisdom from diverse group)

Cons:
1. Information asymmetry: entrepreneurs have more info than individual investors
2. Investor free-ride: investors rely on others to do due diligence
3. Management control: many small shareholders, complex
4. Illiquid shares: often lack a liquid secondary market

  • Regulation: Varies by country, with some nations like the US easing regulations to boost small businesses.
54
Q
  1. Debt-based Crowdfunding & P2P Lending. Definition and example
A

Also called P2P lending. Individuals lend money to entrepreneurs or businesses in for interest payments and the eventual return of the loan amount.
Pros:
• Investors can earn interest
• Lower risk than equity-based: in event of default, legally.

  • Example: Prosper Marketplace, a large P2P platform in the U.S., gets less than 10% of capital from retail investors.
55
Q
  1. Factors Leading to the Rise in P2P Lending:
A

Main reasons for financial innovation: reducing direct transaction costs and reducing information asymmetry.

56
Q
  1. Crowdfunding in Norway
A

from 2020 to 2021, 113% growth

57
Q

Blockchain-based Crowdfunding and ICOs:

A
  • initial coin offerings
  • An ICO is a method of raising capital in the cryptocurrency industry, similar to an IPO in the traditional financial world.
  • Blockchain technology facilitates peer-to-peer transactions, potentially reducing the cost of raising capital.
58
Q

how can bigtech threaten incumbent banks

A

more convenient payment solutions and access to personal data

59
Q

How are Fintech and Big Tech a threat to banks

A
  • Fintech firms are typically small, specialized, and less threatening to incumbent banks, while big tech companies pose more significant threats.
60
Q
  1. Three Scenarios for European Banking in 2030:
A
  • Scenario 1: Incumbent banks maintain their central role in money creation and financial intermediation.
  • Scenario 2: Incumbent banks retrench, and big techs offer financial services, capturing the hard-data, transaction-based lending market.
  • Scenario 3: Central Bank issues digital currency. Restructures the financial society
61
Q

Adverse selection (called, when, mitiage)

A

Called “hidden types”
Problem that occur BEFORE contract is written. E.g., trading partner cannot observe the quality of other partner
Mitigate problem: Signaling, screening

62
Q

Moral Hazard (called, when mitigage, when no?)

A

Problem that occur AFTER the contract is written. E.g., trading partner cannot be sure if the other is behaving OK after the contract is written
Called “hidden actions”
Mitigate: Monitoring
No moral hazard in one-shot transactions: A seller does not need to worry about how a buyer treats a good after it is sold

63
Q

what tools can financial institutions use to mitigate Risk-Shifting Moral Hazard?

A
  1. Collateral
    The borrower now shares the risk of the loan
  2. Debt Covenants
    Terms and conditions that limit the borrowers actions. For example, can limit a company from taking more debt.
64
Q

Q: What are different types of financial innovation?

A

a) Institutional innovation
Creation of new financial firms.

b) Product innovation
New products such as derivatives, securitized assets, foreign currency mortgages and so on. Are introduced to respond better to changes in market demand or to improve market efficiency.

c) Process innovation
New ways of doing financial business including online banking, phone banking and new ways of implementing IT-technology and so on

65
Q

Q: Example of a bad financial innovation that was popular until 2008?

A

a) Collateralized Debt Obligations (CDOs):
Pool together various types of debt, such as mortgages, loans, or bonds, into a single investment vehicle. Divided into tranches that investors can buy.

b) Structured Investment Vehicles (SIVs):
Off-balance-sheet entities created by financial institutions, like banks. Designed to generate profit by borrowing money at a low short-term interest rate and investing those funds in longer term, higher yielding assets.

c) Credit Default Swap (CDSs):
Derivatives contracts that provide insurance-like protection against the default or credit risk of a particular debt instrument, like a bond or loan. Lets say you give a loan to a company. To protect yourself from the risk of default, you buy a CDS. You pay regular premiums to the seller of a CDS, and the seller promises to compensate you if a specific credit event occurs

66
Q

Q: Why did Collateralized Debt Obligations (CDOs) fail during the 2008 crisis?

A

a) Collateralized Debt Obligations (CDOs):
Many of them were backed by mortgage-related assets, particularly subprime loans.

  1. Investment bank (IB) pools together different debt assets, like mortgages
  2. IB creates different tranches for investor with different risk preferences.
  3. Investors invest in these for interest return
  4. Then 2008 hits
67
Q

Q: Why did Structured Investment Vehicles (SIVs) fail during the 2008 crisis?

A

b) Structured Investment Vehicles (SIVs):
Failed due to the heavy reliance on short-term borrowing to finance long-term investments.

Example:
1. A Bank creates a SIV to invest in various assets, like mortgage-backed securities (MBS) and CDOs.
2. The SIV raises funds by issuing short-term commercial paper that pays interest.
3. Investors want higher yields, and buy these commercial papers from the SIV
4. SIV uses this short term funds to invlest in long-term assets, like MBO and CDOs
5. 2008: concern about underlying assets held in SIV (specially those tied to subprime mortgages)
6. Investors become worried: SIV not able to roll over the commercial paper and achieve funding.
- Liquidity crunch
7. SIV forced to sell assets quick
8. This presser price of assets down
9. Substantial losses for SIV and Investors

68
Q

Q: Why did Credit Default Swaps (CDSs) fail during the 2008 crisis?

A

c) Credit Default Swap (CDSs):
Many financial institutions and investors bought and sold CDSs as a form of insurance against default risk. Problem arose when CDS market became highly speculative. Investors betting on failure of certain companies. Failure of one major institution triggered a chain reaction of CDS payouts, causing further financial instability

69
Q

What is Mortgage-backed securities (MBS)?

A

Securitization. Combines mortgages into one large pool, then divides the large pool into smaller pieces based on each individual mortgage’s inherent risk of default and then sell those smaller pieces to investors.

70
Q

What is Asset-backed Securities (ABS)?

A

Asset-backed securities (ABS) are securities backed by the cash flows of a pool of assets. The process involves transfering the ownership of the underlying assets to a special purpose vehicle (SPV) or a trust. The SPV then issues securities backed by the cash flows generated from the underlying assets. Investors can purchase these ABS, which represent a share in the cash flows generated by the underlying assets.

71
Q

What are the options of a company to raise new capital? And what are their cons?

A

a) Loan
Often very expensive due to credit rating of company and the associated rise in interest rates
b) Bond issue:
Often very expensive due to credit rating of company and the associated rise in interest rates
c) Issuance of stock:
Dilute the ownership and control of company

72
Q

Q: Explain the process of pooling and transfer from a company’s standpoint

A
  1. The originator:
    Company wants to raise capital. Loan, bond issue or issuance of new stocks are not preferred.
  2. Revenue-generating assets:
    Company has a constantly revenue-generating part. This part might be more worth than the company as a whole
  3. Transform future cash flows:
    Sells the rights to the cash flows to someone else. Hence, transfers the income stream to a lump sum today.
  4. Creating a special purpose vehicle (SPV):
    To facilitate the transaction, the company creates a special purpose vehicle (SPV). The company then transfer some of its assets to the SPV.
  5. Originator loses claim:
    Once they are here, the company (originator) doesn’t have control or claim over them anymore. Company cant use it to pay its debts.
  6. Involvement of an investment bank:
    The originator often seeks the assistance of an investment bank, known as the arranger, to help structure and set up the transaction.
73
Q

Process of Securitization. Pooling and transfer

A
  1. originator wants to raise capital
    * traditional like loans, bonds or stock issuance not ideal
  2. Company has assets generating revenue (cashflows)
  3. Company sells future rights to cash flows
  4. SPV created (a company)
  5. Assets are pooled and transferred to SPV
  6. Once transferred, originator has no claim on assests. Cannot use it if they eg. goes bankrupt. “bankruptcy remote”

Often facilitated by IB

74
Q

Agency & Info Assymetry & Moral Hazard in Equity-based crowdfunding

A

Agency Problems: Possibility of issuance of new shares, which can dilute ownership

Information Asymmetry: Private firms do not need to public show its financial disclosure

Unlike in publicly traded companies, investors may lack regular, standardized financial reports, making it hard to accurately assess the company’s ongoing performance.

Moral Hazard:
Entrepreneurs provide overly optimistic projections, knowing that they dont have to repay id it fails

75
Q

Agency & Info Asymmetry & Moral Hazard in Debt-based crowdfunding

A

Agency Problems: The risk of default is particularly relevant in debt-based crowdfunding, as borrowers might fail to repay the loan.

Information Asymmetry: Lenders might not have access to the borrower’s credit history or other key details that are typically used in traditional lending to assess risk.

Moral Hazard:
Takes excessive risk after a safety net of crowdfunding money

76
Q

Agency & Info Asymmetry & Moral Hazard in Reward- and donation-based crowdfunding

A

Agency Problems: There’s a specific risk that creators may fail to deliver the promised reward, or the final product may not meet backers’ expectations.

Information Asymmetry: Backers often rely on the project creator’s descriptions and updates, and there are typically no third-party audits or verifications of claims made.

Moral Hazard:
Entrepreneurs can overpromise rewards to secure funding.

77
Q

Agency & Info Asymmetry & Moral Hazard in IOC

A

Agency Problems: Unique to ICOs is the risk of a “pump and dump” scheme, where developers hype up a token to increase its price before selling off their own holdings and disappearing.

Information Asymmetry: The technical complexity of blockchain projects can make it particularly hard for investors to understand the true value or potential of an ICO.

Moral Hazard:
ICO issuers exaggerate the potential of their projects to inflate the value of the tokens and then sell their own holdings for profit. This is also known as a “pump and dump” scheme. This moral hazard problem is especially significant given the lack of regulation and oversight in the ICO space.

78
Q

Big source of info asymmetry in crowdfunding

A

Often no demand for detailed financial disclosure. Can lead to information asymmetry between them.

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