lecture 7 (1)

Question 1

Alternative risk free rates (RFRs)

Answer 1

Are based on overnight wholesale transaction that are unsecured or secured repurchase or “repo” transactions and represnetative of actual market transactions

Question 2

lending rate formula

Answer 2

Risk free + risk premium

Question 3

Eurocredits

Answer 3

are short- to medium-term loans of eurocurrency extended by eurobanks. loans are denominated in currencies other than the home currency of the eurobank

Question 4

Risk sharing agreement

Answer 4

Because the loans are often too large for one bank to handle, Eurobanks will band together toform a bank lending syndicate to share the risk

Credit risk on these loans is greater than on loans to other banks in the interbank market.

interest rate on eurocredits must compensate the bank for the added credit risk

At the end of each period (3-6 months) the loan is rolled over the base lending rate repriced

Question 5

Lending rate (real) formula

Answer 5

Lending rate = term RFR +(Bank credit perimum + lending margin)

Lending margin depending on thecreditworthiness of the borrower

Question 6

A major risk eurobanks face in accepting eurodeposits and in extending eurocredits is interest rate risk resulting from

Answer 6

a mismatch in the maturities of hte deposits and credits

Question 7

F R A involves two parties

Answer 7

a buyer who agrees to pay seller the increased interest cost on a notional amount if interest rates fall below an agreed rate

Soller agrees to pay buyer the increased interest cost if interest rates increase above the agreed rate

Question 8

Euronotes

Answer 8

are short-term notes underwrittedn by a group of international investment or commercial banks called a “facility”

client borrower makes an agreement with a facility to issue euronotes in its own name for a period of time, generally 3 to 10 years

Sold at a discount from face value and pay back the full face value at maturity

Attractive to borrowers because interest expense is usually slightly less in comparison to syndicated eurobank loans

Question 9

Eurocommercial paper

Answer 9

Like domestic commercial paper, is an unsecured short-term promissory note issued by a corporation or a bank and placed directly with the investment public through a dealer

Sold at a discount from face value, like euronotes

Maturities typically range from one to six moths

Vast majority of eurocommercial paper is denominated in the euro and the US dollar

Eurocommercial paper issuers tend to be of much lower quality than their US counterparts
As such, yields tend to be higher

Question 10

CME SOFR futures contract

Answer 10

one month and three month SOFR interest rate future contracts traded onthe CME group are two important contracts

The CME three-month SOFR futures contract is written on a hypothetical risk free deposit of dollars with quarter year maturities

Contract trades in the march, june, september, and december cycle

Contract is a cash settlement contract

Contracts trade out 39 quarters into the future

Question 11

International debt crisis

Answer 11

was caused by lending to the sovereign governments of some less-developed countries (L D Cs)

Question 12

Why did they lend such a huge money to less-developed (and high risk) countries

Answer 12

1) Eurobanks challenge: Want to do with the eurodollar deposits? At some point, they need to pay the interest to thhe depositors (oil countries)

2) Also,there was a pressure from washington to the banks to assist the economic devepment of the “thrid world” countries

The higher inflation, the soaring borrowing costs

It was impossible to less-developed countries to pay back their loans

Question 13

Origin of credit crunch can be traced back to three key contributing factors

Answer 13

1) Liberalization of banking and securities regulation

2) Global savings glut

3) low interest rate environment created by the federal reserve in the early part of this decade

Question 14

Global financial crisis: credit crunch

Answer 14

During this time, subprime mortgages were re-packaged into mortgage-
backed securities (MBSs) to be sold to investors.
The amounts of subprime MBS debt in structured investment vehicles (SIVs)
and collateralized debt obligations (CDOs), and who exactly owned it, were
essentially unknown, or at least unappreciated.
When subprime debtors began defaulting on their mortgages, trading in the
interbank Eurocurrency market essentially ceased and liquidity worldwide
dried up.