Week 5 Flashcards
What is the ABX?
It tells us whats going on in subprime mortgage markets, so basically how risky people think subprime mortgages are.
Which Real Estate investment trust was delisted on March 13th 2007 and then on April 2nd filed for bankruptcy?
New Century
What market cap did New Centiry have?
1,75 billion
What did the rating agencies do in the middle of 2007?
Second, the credit rating agencies, which have taken a fair amount of grief over their overall performance leading up to the crisis, did by the middle of 2007 see the writing on the wall. And began downgrading many of the bonds that they had originally rated, given high ratings early on, when the first came out in 2005 and 2006. We start seeing some significant downgrades with those bonds beginning on June 1, 2007 and going really, basically starting then and going until the fall of Lehman Brothers.
Were the rating agencies the first ones seeing this?
No, they were already late.
How big was Bear Stearns at the beginning of 2007?
the fifth largest investment bank at the beginning of 2007
Why was Bear Stearns in trouble?
Bear Stearns had several funds that were part of its asset management division that were not Bear Stearns shareholders’ money. But it was rather that Bear Stearns had acting as an agent, was investing money for other investors. And it had two funds specifically that were very, very active in subprime securities. These funds ran into a lot of trouble in early June 2007.
How much had Bear Stearns borrowed?
They had borrowed up to about $10 billion to make leveraged investments in subprime securities. And they were unable to make the payments on all of this borrowing, and some of their collateral was seized and sold into the market, and it looked like the funds were going to collapse. Bear Stearns, which was the parent, so it’s not again Bear Stearns’ own asset, it was the parent.
What did Bear Stearns do to the fund that had borrowed so much money?
Bear Stearns suspended redemptions in the fund, so it said, nobody can get their money out of the fund on June 7, 2007
What did Bear Stearns do to this fund?
Effectively they did take this risk back on to their balance sheet and it was a risk of unknown amounts. There were loans that had been made, that had been collateralized by things that were in these funds, that were hedge funds. And Bear Stearns now had these risks by the end of July on their balance sheet. So that’s an important thing to keep in mind for later. As we will see in March of 2008 Bear Stearns had its own story for the whole firm. And the whole firm ended up being purchased, rescued really by a purchase JP Morgan that was supported by the government.
How important was announcement of BNP Paribas on August 9th?
Finally moving now from direct subprime to the even that really kicked off the financial crisis. So it stops being just a housing crisis and a subprime crisis and really becomes a financial crisis or enters what we will call the anxiety period of the financial crisis.
What did BNP Paribas say on August 9th?
On August 9th, 2007 and this is when BNP Paribas, which is a very, very large north of 1 trillion in assets French bank. They also had some funds, some funds that they managed for outside investors and in these funds were subprime securities. And on August 9th BNP Paribas said, we are unable to value exactly what these subprime securities are worth in our funds. We don’t know. We, a very sophisticated, huge firm, is unable to figure out what these subprime securities are worth.
What did BNP Paribas do after they had said this?
We, a very sophisticated, huge firm, is unable to figure out what these subprime securities are worth. And they suspended redemptions in these funds, because you can’t redeem and give people money back if you can’t value what their, what the assets and the underlying fund are worth. This as we will see, really was a massive shock to the market. People started to worry, all market participants started to worry, if BNP Paribas can’t figure out what these things are worth, what hopes do the rest of us have?
What is redemption suspension?
This action is seen as a very negative event for a hedge fund and is used only in extreme situations, as it is preventing investors to access their money. It is also seen as a sign of a major problem within the fund and its management, and will often lead to a run on the fund once the redemption suspension is lifted. Read more: Redemption Suspension Definition | Investopedia http://www.investopedia.com/terms/r/redemptionsuspension.asp#ixzz4CgGyZ0oE Follow us: Investopedia on Facebook
What does the ABX stand for?
Asset backed, and the X is just for index
Are there several types of ABX?
Yes, there are several, we will in particular look at the ABX/HE which stands for home equity.
What does CDS stand for?
Credit défaut swaps.
What is the ABX/HE basically
an index on credit défaut swaps.
What is the price on an ABX essentially?
The price of the ABX index is essentially a measure of the perceived value of subprime securities with various ratings
How is the ABX constructed?
The details of how the ABX is constructed are not crucially important for what we’re going to do. Really all you have to know is there are many firms out there that are writing insurance on subprime securitizations. So somebody bundles together a whole bunch of subprime loans, sells it out into the market. And then if somebody wants to write insurance, wants to say, well how will I be protected if there is actually default on these bonds, then there are various financial institutions that will write that type of insurance. And what the ABX does is average those prices across all the different dealers and tell you this is how much it costs to insure in a sub prime market.
What is a credit default swap?
Many bonds and other securities that are sold have a fair amount of risk associated with them. While institutions that issue these forms of debt may have a relatively high degree of confidence in the security of their position, they have no way of guaranteeing that they will be able to make good on their debt. Because these kinds of debt securities will often have lengthy terms to maturity, like ten years or more, it will often be difficult for the issuer to know with certainty that in ten years time or more, they will be in a sound financial position. If the security in question is not well-rated, a default on the part of the issuer may be more likely. A credit default swap is, in effect, insurance against non-payment. Through a CDS, the buyer can mitigate the risk of their investment by shifting all or a portion of that risk onto an insurance company or other CDS seller in exchange for a periodic fee. In this way, the buyer of a credit default swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the debt security. For example, the buyer of a credit default swap will be entitled to the par value of the contract by the seller of the swap, should the issuer default on payments. If the debt issuer does not default and if all goes well the CDS buyer will end up losing some money, but the buyer stands to lose a much greater proportion of their investment if the issuer defaults and if they have not bought a CDS. As such, the more the holder of a security thinks its issuer is likely to default, the more desirable a CDS is and the more the premium is worth it.
How many rating are there?
And they do this for five different ratings from Triple A down to Triple B for the securities.
By whom was the ABX created?
The index was created by a firm called Markit.
When was the ABX first released?
And it was first released in January 2006, covering the 20 largest subprime securitizations that closed in the last six months of 2005.
If youn look at the 2006-1ABX you get a sense of what?
So when you look at what’s going on in the 2006-1ABX. You’re getting a sense for what the market thinks of securitizations of sub prime mortgages that were written in the last six months of 2005.
Why was this index important although the market slowed down?
At that point, subprime activity really slowed down tremendously, and it was simply too small for any further index construction. But what made the ABX really interesting is that all of a sudden everybody could see. Because there was a public price what the market thought about subprime. So in 2005 there is really no way to do it unless you talk to somebody who themselves was looking very carefully at default and was writing the CDS protection. This is not a public number. Now we have a public number. The Wall Street Journal can write about it
What does this graph tell you?
What it would cost you to insure yourself for a BBB against insurance
What is interesting about the AAA ABX-HE graph?
It has a very small range
What does this graph tell us?
CDO´s are becoming really expensive
What is this graph telling us?
AAA tranches are not safe anymore. In the 4th quarter of 2007 it becomes pretty clear that there are severe probelms for triple AAA tranches.
Why is this picture so important?
It summarises what was going on in the financial crisis.If banks cannot borrow in an unsecured way from each other, if people are concerned about the solvency of their banks, then nobody is going to think of the types of assets that are usually safe assets as being safe anymore. What we are seeing here, in this picture, is essentially a run on the banking system. In the picture we are seeing a run on the banking system
Explain the two sides on the left side and the right side
To ensure, that the conduit itself is safe, they will take the rectangle over on the left, which is a credit enhancement provider. So, somebody will guarantee the credit of the ABCP. So, someone else is standing behind them. And over on the right, a liquidity provider, often a bank, that is giving them a backup line of credit, so that if the investors refuse to roll over their short term debt, the back will provide that, and enable them to pay back the old investors.
What does this graph tell us?
Programms that experience a run are in the earlier years likely to get out of that circle, in the later years not
So think about what this means not only is it the case that far fewer programs are able to borrow but the ones that are still in the market are perceived as being risky enough that investors don’t think it’s really safe to lend them for 30 days or for 90 days. But rather much shorter time periods.
