Overall Revision

Question 1

What is the securitization process?

5 stages

Answer 1

• Origination: Banks originate loans, such as mortgages
• Pooling: The loans are pooled together into a portfolio
• Securitization: The pooled loans are transferred to a special purpose vehicle (SPV) which issues securities back by a loan portfolio
• Sale: These securities are sold to investors
• Servicing: A servicer collects payments from the borrowers and distributes them to the investors

Question 2

What is synthetic securitization/credit derivatives

Answer 2

Credit derivates: financial instruments that transfer credit risk related to an underlying entity (e.g. corporations), between parties without the need to transfer the underlying asset
synthetic securitization is using credit derivates to transfer credit risk

Question 3

Define Asset and Liability Management and why is it impottant?

Answer 3

Asset and liability management: the process of managing financial risks that arise from mismatches between assets and liabilities
- Important to mitigate risks from maturity transformation (interest rate and liquidity risk) by using Duration and duration gap

Question 4

Duration and Duration Gap

Answer 4

Duration: measures the sensitivity of a bond’s price to changes in interest rates
Duration Gap: difference between the duration of assets and duration of liabilities indicate the bank’s exposure to interest rate changes

Question 5

How do central banks control commercial banks?

Answer 5

• by setting reserve requirements
• interest rates on reserves
• High r = high reserve requirement = low risky lending (controls inflation and stabilizes economy)
• Open market operations by buying and selling government securities to influence the amount of reserves in the banking system

Question 6

Why can we not rely on market discipline for regulation?

Answer 6

Market participants may not always have complete information about a bank’s risk exposures, leading to mispricing of risk and delayed corrective actions

Question 7

Why can we not only rely on market regulation?

Answer 7

During periods of excessive risk taking, market discipline may fail to prevent the build up of systematic risks that can trigger financial crisis