Lecture 5 (chapter 8)

Question 1

What is a financial crisis?

Answer 1

Big disruptions (störningar) in the stock markets and it is characterized by asset prices getting declined and firm failures.

It occurs when there is an increase of asymmetric information that prevent lenders giving out capital to borrowers productive investments.

Question 2

USA finanskris?

Answer 2

Beginning of 2007. The biggest financial crisis since the Great Depression and later led to recession.

Question 3

Framwork on how financial crisis evolve:

Answer 3

1. Initiation of financial crisis
2. Banking crisis
3. Debt deflation)

Question 4

Step 1?

Answer 4

Initiation of financial crisis
1. Financial liberalization
2. Asset price boom and bust
3. Spikes in interest rates
4. Increased uncertainty

Question 5

Step 1: Financial liberalization

Answer 5

Elimination of rectrictions in the financial market. Banks can go on lending spree which can be described as credit boom. Risky loans will occur since banks doesn’t have incentives to monitor.

Deposit insurance - leads to even more overly risk investments

Question 6

Step 1: Asset Price Boom and bust

Answer 6

Credit boom can cause asset price boom since people (and firms) have more money to use. Sooner or later, the “bubble” will burst causing a downward spiral of asset prices and decreased net worth at firms.

Question 7

Step 1: Spikes in interest rates

Answer 7

Higher rates attracts “bad” borrowers to loan since they have lower credit risk. That will lead to no loans given out.

Question 8

Step 1: Increased uncertainty

Answer 8

When uncertainty is increased, it leds to more asymmetric information on the market. This slows down the economy.

Question 9

Step 2?

Answer 9

Banking crisis

Question 10

Step 2: Banking crisis

Answer 10

When multiple banks get insolvent, which means that they can’t pay their creditors or depositors, it can lead to bank panic. That’s when depositors “run” to the bank to get their deposits which can result in bank failure. Leads to fire sale.

Question 11

Fire sale?

Answer 11

When banks sell assets to finance the depositors withdrawals during a bank run.

Question 12

Step 3?

Answer 12

Debt deflation

Question 13

ABS?

Answer 13

Asset-backed securities. Flera tillgångar köps, packas som värdepapper och säljs till investerare.

Question 14

SPV?

Answer 14

Special purpose vehicle. Legal entity / corporation. Created as the goals are specific, narrow or temporary.

Gör så att upphovsmannen kan lägga tillgångar / lån utanför balansräkningen.

Question 15

Tranche?
Different tranches?

Answer 15

En del av ett antal värdepapper som erbjuds i en transaktion.

Junior tranche (Equity and mezzanine)
Senior tranche

Question 16

Senior tranches?
Junior tranches?

Answer 16

Get its principle (kapital) and interest paid off first. After that, allocated to mezzanine tranche and then lastly junior tranche.
AAA

Has no lien or second lien (panträtt).
BBB
unrated

Question 17

Difference junior and senior tranche?

Answer 17

Junior tranche are riskier and therefore has a higher interest rate. They are not secured by specific assets (no /second lien).

Question 18

Securities created:

Answer 18

1. Banks lent out to low-credit risk borrowers since they knew all loans were securitized and could be sold off.
2. Adverse selection –> Agency problem increased. The loaners lent out mortgage and only cared about the fee they would get. Didn’t care about the borrower paying back to the investor.

Question 19

CDS?

Answer 19

Credit default swap. A security that promises a payment to the borrower if the firm would default. In return, the buyer is paying premium during intervalls.

Essembling to insurance contract with the difference that they buyer doesn’t have to be in possession of the firm.

Question 20

Effekter finanskrisen:

Answer 20

1. US residential house market collapsed.
2. Deterioration in financial institutions’ balance sheets
3. The shadow banking system lead to economic contractions (nedgångar).
4. Many global financial markets failed since banks weren’t willing to lend to each other
5. Failures of major firms in the financial markets
   For example: Lehman brothers (fourth largest investment bank). Merrill Lynch (sold of to Bank of America for 60% of its price)