Tutorium 2 Flashcards
Define a credit crisis
Sharp reduction in lending, bc. financial institutions face difficulties
Credit crisis —> Housing sector
Hh. can‘t get loans –> can‘t buy houses
–> housing demand down
–> house prices down
Crisis: some borrowers might not be able to repay loans
—> have to sell their houses —> housing supply up
—> house prices down
credit crisis —> labor market
Firms can‘t get loans —> stop investing and hiring
—
Credit crisis —> public finance
unemployment up —> state has to pay social benefits
—> economic activity down and tax revenues down
—> uncertainty: interest rates on state debts go up
—> costs for the gov‘t up
—> Bailout of large companies
—> gov‘t has to rescue companies & economy
—> fiscal stimulus (subsidies for a new car, etc.)
Why: long-term unemployment worse than short-term ue.
Short-term:
• can be beneficial for the match between firms and employees
long-term
• long-term makes it harder to find a job (skills get lost)
• expected wages down
Definition: Recession (from NBER)
NBER= National Bureau of Economic Research
recession= GDP declines for at least 2 consecutive quarters
Definition: Asset price bubble
Prices of an asset (houses, stocks, gold) become over-inflated and are not supported by underlying demand
interest rate —> fundamental value of an asset
Negative correlation.
Interest rates tells, how much future payments are discounted. The more you discount them, the lower the fundamental value.
r(f) = 5%
house value = 100.000 $
What is the rental revenue?
5% * 100.000 = 5000/year
Definition: Asset price bubble
Prices of an asset (houses, stocks, gold) become over-inflated and are not supported by underlying demand
interest rate —> fundamental value of an asset
Negative correlation.
Interest rates tells, how much future payments are discounted. The more you discount them, the lower the fundamental value.
r(f) = 5%
house value = 100.000 $
What is the rental revenue?
5% * 100.000 = 5000/year
rents = 3.000 / year
r(f) = 0%
house value in t(1) = 100.000$
What is the NPV?
(3000/1,0^1) + (100.000/1,0^1) = 103.000
rents = 3000/year
r(f) = 3%
house value in t(1) = 100.000
What is the NPV?
(3000/1,03^1) + (100.000/1,03^1) = 100.000
Bond: T = 1 C = 10$ V = 100$ r(f) = 10% default rate = 1%
What is the NPV?
NPV = (10/1,1^1) + (100/1,1^1) - 100*0,01 = 99$
Bond: T = 1 C = 10$ V = 100$ r(f) = 10% default rate = 1%
—> trades at present value 99$
What is its return?
0,99 * (110-99) + 0,01 * (0-99) = 9,9
in %: (9,9/99) = 10%
Mortgage backed security:
T = 1
collateralized: only interest payments can be lost
based on 2 different mortgages: T = 1 rent = 10.000 value = 90.000 default rate = 10% r(f) = 5% —> risk uncorrelated
NPV of this MBS?
Case Probability
no default 0,9 * 0,9 = 0,81
one default 0,9 * 0,1 = 0,09
two defaults 0,1 * 0,1 = 0,01
expected payments:
0,81 * 2 * (90.000 + 10.000) —> no default
+ 2 * 0,09 * (90.000 + 90.000 + 10.000) —> one default + one d.
+ 0,01 * 2 * 90.000 —> two defaults
= 198.000
198.000 / 1,05^1 = 189.000
Mortgage backed security:
T = 1
collateralized: only interest payments can be lost
based on 2 different mortgages: T = 1 rent = 10.000 value = 90.000 default rate = 10% r(f) = 5% —> always default together
NPV of this MBS?
expected payoff:
0,9 * 200.000 + 0,1 * 180.000
= 198.000
198.000 / 1,05^1 = 189.000
Mortgage backed security:
T = 1
collateralized: only interest payments can be lost
based on 2 different mortgages: T = 1 rent = 10.000 value = 90.000 default rate = 10% r(f) = 5%
What is the probability of ending up with less money than invested?
(correlated and independent risk)
independent risk:
one default: 90.000 + 90.000 + 10.000 = 190.000 > 189.000
two defaults: < 189.000
—> 1%
correlated risk:
—> 10%
How can decrease in asset prices be amplified through borrower‘s balance sheet?
Decline in asset prices —> worse balance sheet —> no chance to buy more assets —> demand for assets down —> asset prices decrease further
small shock to the balance sheet of the bank —> bankrupt
Creditors believe, that other creditors will be worried
—> stop funding this bank
—> bankruptcy
Definition:
The originate and distribute bank model
• banks do not keep the loans in their own balance sheet
—> sell them to e.g. funds
—> receive new money for new loans —> don‘t have to use own capital
• the funds package multiple loans to a portfolio, distributed by risk
How does the originate and distribute model affect the incentive of a bank, to monitor its borrowers?
They have less incentives to monitor,
bc. they won‘t be affected by failures of loans they originated
Advantages of repackaging loans into new securities
- enables banks to increase the diversification of portfolios
- increases capital ratio if the securities receive a good rating
- selling the securities makes new money, that can be used for safer projects —> diversification
- fit the products better to risk preferences of different investors
