Lecture 11 Flashcards
Why are ethics important in financial markets?
Participants need confidence that markets are fair and transparent
ASIC and ASX play role in policing
What are some areas of ethical behaviour to consider?
Professionalism
Integrity of Capital Markets
Duties to Clients
Duties to Employers
Investment Analysis, Recommendations and Actions
Conflicts of Interest
What is some background from financial crises?
Situations where market prices fall quickly, volatility
increases, credit may become scarce and investors panic.
They will often lead to a reduction in economic growth and
possibly recessions.
Arguably they have become more frequent as markets have
become more integrated with deregulation and
technological advances.
What happened in the 1929 crash?
20’s was a period of sustained economic growth. In late 1929 market fell 40% in three weeks
by 1932 dow jones had lost 90% of its value
Great depression followed
Price bubble or change in fundamentals?
What happened in the 1987 crash?
From 1982, Australian share market experienced
sustained growth.
In October 1987 All Ordinaries Index fell approximately
30% in a day.
Most of these were gains from the previous year.
It took almost 10 years for the market to recover these
losses.
What happened in the Asian financial crisis?
Sustained economic growth and increasing asset prices
occurred in Asia in the 1980’s and early 90’s.
In these countries excessive bank credit was available and
there was a reliance on short-term funding from overseas.
When the level of economic growth did not keep pace
with the increasing debt, overseas investors withdrew their
funds, putting downward pressure on the Asian currencies.
Arguably, the somewhat fragile domestic financial systems
contributed to the crisis.
This spread to other countries and became an economic
as well as a financial crisis.
What happened in the GFC?
In October 2008 the Australian share market fell nearly
16% in a week and 40% over the next 12 months. The
value of the AUS relative to the USD depreciated by
28% from AUD/USD0.9626 in June 2008 to
AUD/USD0.6928 in December 2008.
Similar scenarios were occurring in the major financial
markets around the world.
What are subprime mortgages?
US Federal Reserve maintained low interest rates to
stimulate economic activity.
This low-cost finance increased demand for housing and
generated a property price boom.
In addition, credit standards were lowered and hence loans
were being made to borrowers who would find it difficult to
repay the loans.
These loans became known as sub-prime loans.
When large numbers of defaults occurred, bank foreclosures
increased with the selling pressure pushing property prices
down and making it difficult for banks to recover the full
amount of the loans.
What happened with the liquidity crunch?
A liquidity crunch developed as investors became very
hesitant when investing and financial institutions began to
cutback on their lending in the inter-bank market and also
normal lending to individuals and corporations.
Consequently, the sub-prime crisis became a global credit
crisis.
Central banks tried to relieve the crisis by pumping massive
amounts of funds into the financial system.
Most governments used stimulus packages to boost growth.
Turmoil in the financial markets saw global economic
activity slow considerably with many countries experiencing
recessions.
What are the factors of a financial Crises?
Usually follow a period of sustained asset price increases
fuelled by easy credit (and low interest rates?).
Lack of liquidity of markets in times of crisis.
Link between markets (Globalisation and Contagion).
Tendency for policymakers and managers to forget the
lessons of past crises (failure of risk management
policy and practice).
Behavioural Factors?
What happened with Nick Leeson?
Barings
Nick Leeson
Traded futures and options on equities and bonds.
What was originally an arbitrage strategy between contracts
on different futures exchanges became a speculative
strategy as losses mounted.
Large amount of autonomy in his activities.
US $1.4b
What happened with Yasuo Hamanaka?
Sumitomo
Yasuo Hamanaka
Copper Trading
Believed to control 5% of the world copper market.
Prices declined by over a third in two months.
Losses accumulated over a 10 year period of trading.
US $2.6b
What happened with Robert Citron?
Orange County
Robert Citron
Leveraged Bond Investments
Took out highly leveraged positions to boost the returns
to the County in a low interest rate environment.
When interest rates rose, massive losses resulted due to the
leveraged nature of his positions.
e.g. If rates 4%, then pays [Rate – 4%] x 10
When rates @6%, pays [6 – 4] x 10 = 20%
US $1.7b
What happened with Hammersmith and Fulham Council?
Hammersmith and Fulham Council
Interest Rate Swaptions
Wrote a large amount of swaptions (positions worth
4.2b GBP or 10% of the British market when they had
assets of 300m GBP), betting that interest rates
wouldn’t rise.
When rates went from 8% to 15%, made massive losses.
Pleaded Ultra Vires (legal inability to enter contracts)
and won in House of Lords.
What happened with Namoi Cotton?
Namoi Cotton
Cotton Futures
Selling Hedge:- Worried about a fall in price, so sold futures
If price falls, loses in the spot market, but wins on the futures
If price rises, wins in the spot market, but loses on the futures
When cotton price rose significantly, they lost on futures,
but won in the spot market (sold cotton at a higher price).
Unfortunately actual crop was only half the size of the
futures contract so they lost twice as much on the futures
as they gained in the spot market and ended up with
significant losses (double sold).
Could have:
- Only hedge a portion of the crop (e.g. 50%).
- Use options to hedge as flexibility is useful when
hedging an unknown quantity.
