Lecture 5

Question 1

What is shadow banking?

Answer 1

The group of non-bank financial intermediaries collectively conducting maturity, credit, and liquidity transformation

Question 2

What are the REPOs?

Answer 2

They are like short-term loans collaterized by an asset.
The lower the quality of the collateral the higher the haircut.

Question 3

What are Money Market Mutual Funds (MMMFs)?

Answer 3

Open end funds that can only invest in a diversified portfolio of liquid (very short term maturity), low-risk assets.

Question 4

Why does the breaking the buck happens?

Answer 4

1. Assets in the MMMFs can default
2. They can become illiquid and redemptions increase (asset spiral) (many people want their money back -> sell assets below fair value)

Question 5

What are the solutions for electronic runs?

Answer 5

Narrow banking
Suspension of convertibility

Question 6

What did regulators do for electronic runs?

Answer 6

Floating NAV for institutional investors
Redemption gates
Liquidity fees
Diversification, risk definition, and Stress Testing

Question 7

What is securitization?

Answer 7

Transformation of illiquid assets into marketable securities, like a bond that promises to make future payments out of cash flows of the underlying pool of collateral assets.

Question 8

What are the advantages of securitization for the originators?

Answer 8

SPVs do not go bankrupty (less costly)
Manage maturity mismatch
Manage capital requirements
ABS value is higher than value of its underlying assets, because they are tradable securities and can create safer securities that get AAA rating to use them as collateral.

Question 9

What are the advantages of securitization for the investors?

Answer 9

Exposure to different asset classes (e.g., mortgages)
Exposure to different risk-profiles (e.g., accelerated sec.)
Know where payoffs are supposed to come from

Question 10

What are the advantages of securitization for the economy?

Answer 10

More and/or cheaper capital available for (small) firms and individuals

Question 11

Risk retention in Europe

Answer 11

Pari passu share → Retain at least 5% of nominal exposure
Vertical slice → retain at least 5% of each tranche
Random selection → retain random exposures (>5%)
Junior tranche retention → retain first-loss tranche(s)

Question 12

Risk retention in US

Answer 12

Vertical retention: >5% of each tranche
Horizontal retention: retain first loss tranches (if at least 5% of whole deal)
L-retention: hybrid of vertical & horizontal retention

Question 13

Conflicts between originator, arranger and investors

Answer 13

1. Fraud, originators might hide the quality of the loans to the arrangers
2. Adverse selection, arrangers may systematically securitize assets they expect to decrease in value and keep the “good” assets