Week 2

Question 1

Economic environment

Answer 1

-Government encouraged: Low interest rates & increased home ownership demand

-Reduction in saving rate, Increase of consumer debt

-Gov put pressure on lenders to lend to low income households, contributed to housing bubble

Question 2

Subprime mortgage

Answer 2

Given to people with poor credit history

Question 3

Adjustable rate mortgages

Answer 3

Allow low interest rate for 2-3 years, followed by a higher interest rate

Question 4

Housing bubble

Answer 4

Combination of low interest rates & relaxed mortgage lending standards, led to greater demand for housing and a rise in house prices

Question 5

Leveraging cycle (opposite for deleveraging cycle)

Answer 5

-Investors allows to increase leverage

• They buy more assets
• Asset price increases
• Leverage of investors decreases

Question 6

Irrational exuberance

Answer 6

Unsustainable investor enthusiasm that drives asset prices up (to levels that aren’t support by fundamentals)

Question 7

Bubble burst

Answer 7

-2nd half of 2006 housing demand began to fall

-House prices increased, demand for houses decreased

Question 8

Securitisation

Answer 8

Packaging up assets into new financial structure

Question 9

Asset backed security (ABS)

Answer 9

Security created from the CF of financial assets e.g mortgages, auto loans, credit card receivables, loans

Question 10

How ABS works

Answer 10

Collection of loans transformed into tradeable instrument