Term
| Secondary markets help with |
|
Definition
| more liquidity & information, less search costs & transaction costs |
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Term
| Secondary markets can be structured by |
|
Definition
| organization (centralized exchanges or over-the-counter like the nasdaq) or timing (continuous trading or a call market of intermittent auctions) |
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Term
| What are the characteristics of the benchmarket market discussed in class? |
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Definition
| participants are price takers, there are no frictions or restrictions, broker/dealer market |
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Term
|
Definition
| security finding, lowers matching problems |
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Term
|
Definition
| maintenance of position, perpetually available to trade (immediacy), deals with flow imbalance, dealers risk their own capital |
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Term
| Dealers are concerned with being taken advantage of by |
|
Definition
| informed traders. uniformed traders are the ones they want to trade with. Need to learn about counterparty characteristics |
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Term
| Operational efficiency of the market means it is |
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Definition
|
|
Term
| Operational efficiency of the market is not the norm because of |
|
Definition
| collusive/fixed brokerage fees, capital intensive bond trading with no central clearing |
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Term
| Market efficiency requires |
|
Definition
| operational efficiency, i.e. clearing and transaction costs, and pricing efficiency |
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Term
| The NYSE is what kind of system? |
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Definition
| the NYSE is a specialist, action type system - each stock has 1 specialist |
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Term
| NYSE trades are executed by |
|
Definition
| brokers directly or electronic order submissions called SuperDOTs |
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Term
| What does an NYSE specialist do? |
|
Definition
| match orders, keeps limit order book (now visible to all), trades on own account occasionally/infrequently to "maintain orderly market" perhaps providing better prices, not 100% profit maximizers, keeps bid-ask spread small between transactions, arrange opening price, can close market |
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Term
| The presence of a dealer in NYSE has what effect on speed of trades? |
|
Definition
| Dealers slow execution of trades in NYSE |
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Term
| The NASDAQ is what kind of market? |
|
Definition
| Over-the-counter market, fully electronic from founding - dealers contacted by phone until 1987 |
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Term
| How does the NASDAQ treat small orders? |
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Definition
| It is required to honor small orders |
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Term
| What is the SuperMontage? |
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Definition
| The NASDAQ is moving toward a hybrid market, called a SuperMontage, of order-driven and quote-driven trading |
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Term
| Where do Non-NASDAQ, unlisted stocks trade? |
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Definition
| OCTBB (bulletin board) is a regulated electronic quotation service file with SEC with small number of stock, pink sheets run by a private corporation but risks price manipulation |
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Term
| What do investment banks do? |
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Definition
| Securities underwriting (stocks/bonds), equity sales, M&As, brokerage services, dealer services, alternative trading arrangements |
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Term
| Security issuance is done by... |
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Definition
| IPO or SEO, initial public offering or secondary equity offering if already public |
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Term
| Underwriters who do IPO/SEOs have what types of commitments? |
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Definition
| Firm commitment or "best efforts" |
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Term
| What is an underwriter "firm commitment"? |
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Definition
| Underwriter buys the IPO or SEO and resells it, all on them |
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Term
| What is an underwriter "best efforts" commitment? |
|
Definition
| Underwriter tries to place issue at given price |
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Term
| What are the steps of the IPO process? |
|
Definition
| (1) choose an underwriter, (2) manage/define the IPO terms, (3) issue letter of intent, (4) register the issue with the SEC, (5) go on the "Road Show", (6) decide "Effective date", (7) final prospectus, execution, SEC approval, stock opens for trade |
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Term
| Choosing an underwriter involves |
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Definition
| underwriter reputation and association, analyst coverage, underwriter client base, prior relationships....NOTE: Choice is NOT based on price of IPO services - fee is generally set, mostly around 7% |
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Term
| How much do firms usually charge for IPO services? |
|
Definition
|
|
Term
| Who manages the underwriting of an IPO? |
|
Definition
| Can be sole managed, or from a syndicate with a "lead underwriter" |
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Term
| The role of the managing underwriter includes... |
|
Definition
| making arrangements with an issuer, establishing schedule, primary due diligence, pricing/distribution of stock |
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Term
| The fee split for underwriters goes... |
|
Definition
| 20% to lead underwriter, 60% proportionally split to co-managers based on how much issued, and 20% for other expenses |
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Term
| What is the letter of intent? |
|
Definition
| Issuer promises to repay costs if IPO is canceled, also says gross spread, type of IPO commitment, due diligence and disclosure, "Greenshoe option" |
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Term
| What is the "Greenshoe option"? |
|
Definition
| The Greenshoe option is an agreement to grant 15% overallotment option to underwriter |
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Term
| How is an IPO/SEO registered? |
|
Definition
| Via securities act of 1933, (1) Prospectus, (2) Part 2 only available to SEC. Reason for registration is to give info to public, requires due diligence, public can sue if false info |
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Term
| The registration IPO/SEO statement may be considered a "Red Herring" because... |
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Definition
| The registration statement becomes a preliminary prospectus when filed |
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Term
| What is wait time for SEC registration approval? |
|
Definition
| The SEC responds within 20 days to say everything has been filed |
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Term
| How is the prospectus generally created? |
|
Definition
| The registration/Red herring is amended |
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Term
| When and how does the "Road Show" occur? |
|
Definition
| The Road Show occurs during the circulation of the "Red Herring", and lasts 3-4 weeks. Presents to institutional investors + retail sellers |
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Term
|
Definition
| Bookbuilding is when an underwriter receives indications of interest in purchase of the stock - retails investors submit market orders, instutional investors sumbit limit orders |
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Term
| Are any shares actually sold during bookbuilding? |
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Definition
| NO, by law, no shares are actually sold during Bookbuilding |
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Term
| How is the effective date chosen for an IPO/SEO? |
|
Definition
| Underwriter gets to choose effective date, meets before to decide price and number of shares - effective date never on Monday |
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Term
|
Definition
| IPOs are oversubscribed...price set such that demand is 2 to 3x as much needed to place issue, E.G. underpricing...always positive first date returns! |
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Term
| Some explanations for IPO/SEO unpricing? |
|
Definition
| risk (not possible, it's alpha? risk free?), information asymmetry (risk of winner's curve, reward for honest reports, underpricing signals quality), litigation risk (section 2 of securities act of 1933), kickbacks (30% to 40% for underwriters) |
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Term
| What is the "price amendment" the underwriter files? |
|
Definition
| It's the partial adjustment phenomenon, small change in price |
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Term
| How many days after an IPO/SEO does it take for a company to deliver the stock? |
|
Definition
|
|
Term
| How does a company actually get the money from an IPO/SEO? |
|
Definition
| The underwriter deposits net proceeds with the company |
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Term
| What are the risks to an underwriter? |
|
Definition
| legal risk, reputational risk, price risk (mostly irrelevant in US, but see BP issuance as huge loss for underwriter) |
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Term
| What are the traits of SEOs as opposed to IPOs? |
|
Definition
| Raise more equity generally, much lower fees, occur usually shortly after IPO, fewer information problems, COULD cause dilution... |
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Term
| On Black Monday in 1987, how much did the DJIA drop? |
|
Definition
| 2500 to something like 1750 |
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Term
| Fees are more or less for SEO spreads? |
|
Definition
| less, between 4 and 6 percent |
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Term
| What problems do investment banks solve and how? |
|
Definition
| Information asymmetries, conflicting objectives, ill-defined property rights...create and trade complex bundles of promises and property rights |
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Term
| What is requires for investment banks to function relatively well? |
|
Definition
| Sophisticated and well-functioning legal system |
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Term
| Development of investment banks began with... |
|
Definition
| securities markets by Bank of England for borrowing in war with France, 1694...caused merchant networks to develop |
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Term
| What was the first ? financial security? |
|
Definition
| Bill of Exchange, 13th Century Italy - effectively, a transferable IOU |
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Term
| Investment banks were started from |
|
Definition
| merchant banking houses with good reputations that strated specializing in financial transactions (discounting) |
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Term
| What is a Bill of Exchange (BOE) (old security?)? |
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Definition
| London merchant sells goods to Amsterdam buyer, accepts BOE as promise to pay after delivery. London merchant doesn't get money, sells bill to Amsterdam trader...trader then can use for payment in Amsterdam - default works back through chain |
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Term
| What is required to issue a BOE back in the day? |
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Definition
| reputation! needed to be internationally active to guarantee, smaller merchants would get bigger firms to guarantee...many investment banks got rid of the original trading business to focus on the DISCOUNTING business |
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Term
| Early example of I-Banking: The Rothschilds, who were they? |
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Definition
| Linen traders, began an I-Bank by placing loan to Prussian gov, ended up as London agents for US Treasury. Only used FAMILY network, hardly ever paid agents |
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Term
| Who was the family that did I-Banking with Prussian gov? |
|
Definition
|
|
Term
| Why was the NYSE developed? |
|
Definition
| Created because of unenforceable securities contracts from anti-speculation LAWS left over from South Sea Bubble/1792 crash, e.g. NY/MA wouldn't acknowledge short sales and PA/MD voided futures contracts. |
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Term
| When was the NYSE developed? |
|
Definition
| NYSE and board formed in 1817 to exclude individuals who broke contracts with members, monitored credit, even with non-legally enforceable stuff, became an INFORMATION NETWORK |
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Term
| How has security underwriting developed? |
|
Definition
| Movement of "public debt placements" from open public subscripts to "lists". These "lists" are "monied men" who buy a proportion of the government "stock". Intermediaries controlled lists and had lots of bargaining power. |
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Term
| How were members of "lists" in security underwriting policed? |
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Definition
| Contractors would use oversubscription. Despite this, many early loan contractors failed |
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Term
| Investment banking in the USA start and grew how? |
|
Definition
| Started with government debt. Then moved to financing railroads via big business/capital intensiveness/RISK! This caused charterest banks to enter the market for buying debt issues and passing them on. |
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Term
| What was the primary role of investment banking in the US, when it was getting started? |
|
Definition
| US I-Banks role was to allow capital from Europe to flow to US |
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Term
| Mortgage originators include |
|
Definition
| banks and similar entites, and pure originators with no capital invested |
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Term
| What are the sources of profit in the mortgage market? |
|
Definition
| Origination fee, secondary market profit (if rate rise, take a loss and vice versa), servicing fee |
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Term
| How are underwriting standards set? |
|
Definition
| Payment to income ratio, loan to value (LTV) ratio, and documentation (no doc/low doc, "liar loans", NINJA) |
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|
Term
| How are residential mortgages classified? |
|
Definition
| Priority, credit (prime, subprime, GSE insured), or interest rate (fixed rate, adjustable rate [ARM], option ARM) |
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|
Term
| What is the GSE cutoff number? |
|
Definition
| 620 credit score. Note, default rate jumps right above 620 |
|
|
Term
|
Definition
| Reduces monthly payment so pay down less of the principal, big jumps, could always refinance as long as housing prices rise |
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Term
| Some alternative ways of classifying mortgages? |
|
Definition
| credit guarantees (gov loans like FHA, VA, or Fannie May and Freddie Mac), jumbo (above $417k versus conventional), prepayment penalties (costly to mortgage holder since prepay when interest rates fall), conforming v nonconforming |
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|
Term
| What is a conforming versus nonconforming mortgage? |
|
Definition
| conforming mortgages are eligible to be sold to GSEs, have documentation, are large enough, have good credit score |
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Term
|
Definition
| Residential Mortgage Backed Securities |
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|
Term
| What is the difference between agency and nonagency MBS? |
|
Definition
| Ginnie Mae, Fannie Mae, Freddie Mac or the Federal Home Loan Banks issue security if agency |
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|
Term
| What is a subprime mortgage? |
|
Definition
| Poor people mortgage, the redlined neighborhoods, very popular in 2005 and 2006 (1.2 trillion), 80% securitized....essentially cannot be repayed without capital gains on the home |
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Term
|
Definition
| Avoiding lending in minority neighborhoods |
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Term
| Repayment of a subprime mortgage is only possible when... |
|
Definition
| the home experiences capital gains, via colalteral for new loans or withdrawing for consumption |
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Term
| Who holds subprime mortgages? |
|
Definition
| CDOs are populated by RMBS. CDOs designed to be held in portfolios of ABS, RMBS, and CMBS...basis for synthetic or hybrid CDOs (CDS's) |
|
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Term
|
Definition
| Collateralized debt obligation |
|
|
Term
|
Definition
| Credit Default Swap...synthetic or hyrid CDOs |
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|
Term
| How do synthetic CDO's effect net securitization? |
|
Definition
| They DONT! opposite positions don't effect net securitization, only increase spread of risk, decrease transparancy |
|
|
Term
|
Definition
| Structured Investment Vehicle (SIV) |
|
|
Term
|
Definition
| Asset backed commercial paper (ABCP) |
|
|
Term
| Housing price decreases led to what? |
|
Definition
| Run on SIV's and ABCP conduits, which had bought the CDOs containing RMBS |
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|
Term
| What are some information problems with subprime mortgages? |
|
Definition
| Risk information is lost in repackaging. In 2006, it was somewhat show in the ABX.HE index..but in 2007 the price plummeted, so knowing there was a big risk didn't help because you couldn't determine where the risk was |
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|
Term
|
Definition
| The ABX.HE was a synthetic index of subprime risk introduced in 2006, that plummeted in 2007 |
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|
Term
| What are some difficulties with subprime borrowing? |
|
Definition
| Borrowers may have low funds for downpayments, credit issues, and undocumented income...borrowers may also be uninformed about risky activities and credit problems that can come up |
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|
Term
| What is the Grameen bank? |
|
Definition
| Community dvelopment bank in Bangladesh that makes small loans to the poor with no collateral, idea is that these poor have skills that are under-utilized |
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Term
| What did Bank of America do to deal with subprime borrowers? |
|
Definition
| Neighbood Advantage Zero Down (good credit, 100% LTV) & Neighborhood Advantage Credit Flex (For "alternative" credit history) |
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|
Term
| What are the basic characteristics of subprime loans? |
|
Definition
| borrowers can't afford sufficient rates, so loan for short term with teaser rates and assume refinancing from growing wealth in home equity. BIG step in interest rates after 2-3 years for force refinancing |
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|
Term
| What is the greater fool theory? |
|
Definition
| Greater fool theory: belief held by one who makes a questionable investment, with the assumption that they will be able to sell it later to "a greater fool" - e.g. 30 yr mortgages, assume housing value always go up |
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|
Term
| Characteristics of a subprime borrower? |
|
Definition
| Default in last 2 years, two or more 30 day delinquincies in last year, one or more in 60 day delinquency, FICO<660, debt service/income < 50% |
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|
Term
| What is the FICO score of subprime borrower? |
|
Definition
| FICO of less than 660, or 620 for securitization/GSE |
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|
Term
| Are subprime loans very hetero or homo geneous? |
|
Definition
|
|
Term
| What does 2/28 or 3/27 ARMS mean? |
|
Definition
| The first number means how many years of teaser fixed rate, then how many years of adjustable rates - at that point, we assume readjustment |
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|
Term
| How much do prepayment penalties apply for subprime and prime mortgages? |
|
Definition
| 80% of subprime have prepayment penalties, only 2% of prime have prepayment penalties...this is an implicit option for lender to obtain the house if they don't allow refinance |
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|
Term
| Essentially, the lender is long or short in the house? |
|
Definition
| long in the house, with option to extend loan...sequence of options...lender has compound option. If borrower can get the first loan again when housing prices go up, he can extra equity from the home |
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|
Term
| If borrower can get loan again when housing prices go up... |
|
Definition
| they can extract equity from the home |
|
|
Term
| What is the history of the subprime market? |
|
Definition
| '98-'06, subprime worked, more than 50% refinanced before 5 yrs. more than 50% involved equity extraction. |
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|
Term
| Subprime mortgages are very sensitive to... |
|
Definition
| housing appreciation and depreciation |
|
|
Term
| Subprime mortgages are primarily financed through |
|
Definition
|
|
Term
| The primary source of cash flow from subprimes is |
|
Definition
| prepayment through refinancing |
|
|
Term
| Cash flow from subprime mortgage securities are distributed based on |
|
Definition
| triggers relating to prepayment/default, degree of credit enhancement is dynamic |
|
|
Term
|
Definition
| (1) senior/subordinate shifting of interest structure, (2) excess spread/overcollateralization (used for subprime) |
|
|
Term
| Explain the use of excess spread/overcollateralization |
|
Definition
| interest paid into deal is MORE than coupon payments on RMBS. More collateral than face value, initially |
|
|
Term
| What is the difference between prime and subprime tranches and default risks? |
|
Definition
| Prime loans have fixed tranches and assuming early default is conservative for prime, where in subprime the tranches can be changes/paid off and early default is likely |
|
|
Term
| For subprime tranches/credit exchancement... |
|
Definition
| excess spread is used, based on targets, to exhance credit of the tranches as the excess is paid out to residual holders. No longer available to cover losses |
|
|
Term
| Deal structure, Prime & Alt-A |
|
Definition
| 6-pack deal (6 broad rating grades generally issued by rating agencies), no overcollateralization |
|
|
Term
| What are the tranches of Prime & Alt-A securities? |
|
Definition
| AAA is "Senior", AA,B,BBB is "Mezzanine", BB,B,unrated (subordinated). NOTE: unrated tranche is pretty much equity |
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|
Term
| How is the length of lockout reduced for Alt-A and Prime securities? |
|
Definition
| In early years of deals, prepayment allocated top-down...increases % of collateral covering mezz. and sub. tranches |
|
|
Term
| How are subprime deals structured? |
|
Definition
| overcollateralized (OC), from either structure or excess spread. initially pay down senior, freeing collateral for mezz and sub. tranches |
|
|
Term
| When can net interest margin securities be paid for subprime deals? |
|
Definition
| when OC targets are reached, OC can be paid to residual holder |
|
|
Term
| How is the stepdown date determined for subprime deals? |
|
Definition
| It is the later of either the specified month of the deal, or when senior credit enhancement reaches some point..prior to this, 100% of prepayments to senior tranches |
|
|
Term
| What is the lockout for an RMBS? |
|
Definition
| No prepayments to mezzanine and subordinate bonds (sequential amortization), senior is the only paid |
|
|
Term
| What is the step down for an RMBS? |
|
Definition
| After good performance, i.e. OC, they'll use prepayments to enhance subordinated tranches |
|
|
Term
| What is cross-collateralization for an RMBS? |
|
Definition
| Several tranches pull from the same pool of OC, but only one tranche may pull from several pools |
|
|
Term
| What are performance triggers and their results for an RMBS? |
|
Definition
| Delinquency and loss...when trigger is tripped/fails, principal payments to mezz and sub tranches are delayed or stopped...prevents reduction in credit enhancements for senior tranches |
|
|
Term
| How are coupons paid on RMBS? |
|
Definition
| Minimum of index (say, 1-month LIBOR + margin) or weighted average AFC. Floating coupon with XS/OC, but underlying mortgages pay fixed rate until reset. May not have enough interest to make payments |
|
|
Term
|
Definition
| Available Funds Cap, maximum interest the RMBS or whataever will pay based on available funds |
|
|
Term
| The SAILT Structued Asset Investment Loan Tool '05-'06 was notable because of... |
|
Definition
|
|
Term
| The difference between the Ameriquest AMSI and the SAILT was... |
|
Definition
| the date which they started! AMSI passed triggers, built of colalteral, increased subordination for mez/sub...SAIL deal didn't have housing prices rise, so refinancing was harder and ratings downgraded |
|
|
Term
| Higher subordination means... |
|
Definition
|
|
Term
| Standard securitization has fixed or variable tranche size? |
|
Definition
| fixed. Exception for subprime where size depends on reinancing, which depends on house prices due to implicit option/requirment to refinance |
|
|
Term
|
Definition
| Via SPVs issuing long-dated liabilities in rated tranches, purchase tranches of asset backed securities including subprime and Alt-A deals...can be activitely managed at first, can reinvest cash...managers generally own all/part of equity of CDO, potential for risk shifting |
|
|
Term
| When is a CDO default triggered? |
|
Definition
| Can be strcutured to default giving control senior holders, default triggered when minimum overcollateralization not maintained |
|
|
Term
| In 2005, what happened to CDO composition? |
|
Definition
| Heavier in BBB tranches of subprime, CDOs became heavier in subprime, not common knowledge, no consistent with spread |
|
|
Term
| Negative basis trade involves... |
|
Definition
| Bank buys CDO AAA tranche, purchases CDS on same tranche...books NPV of transaction (excess yield on CDO over protection payment) |
|
|
Term
| What is the problem with negative basis trade? |
|
Definition
| Doesn't account for counterparty risk on CDS! Could not be able to pay it....profit is compensation for risk that the CDS will not pay |
|
|
Term
|
Definition
| These exploit the difference in financing costs versus yields paid...should be gotten rid of by efficient markets |
|
|
Term
| What are balance sheet CDOs? |
|
Definition
| These remove risks from the balance sheet of the originator, in regulatroy capital relief |
|
|
Term
| In 2005-2007, what happened to ABS CDOs? |
|
Definition
| Trippled over 2005-2007, more US subprime RMBS concentration |
|
|
Term
| Four ways to protect against default by borrower... |
|
Definition
| (1) sell loan (but can impair borrower relationship), (2) securitize and sell, (3) CDS, (4) CDO |
|
|
Term
| What are the 6 default events that can trigger a CDS? |
|
Definition
| Bankruptcy, credit event upon merger, downgrade, failure to pay, repudation/moratorium, restructuring |
|
|
Term
| What is repudiation/moratorium? |
|
Definition
| Reduced interest payment, reduced principal, rescheduling of principal, change in seniority |
|
|
Term
|
Definition
| Pay fee in exchange for payment in credit event, traded in OTC market, no central clearing, physical delivery occurs by paying par value for securities/cash delivery |
|
|
Term
| What are the delivery options for a CDS? |
|
Definition
| Physical (insurer pays par value for securities, cheapest to deliver) or Cash |
|
|
Term
| What's good about the CDS market for participants? |
|
Definition
| Liquidity in swap market is high, more efficient way to take a position. Easier than selling in some cases, shorting corporate bonds is hard...equivalent to a levered position in a corporate bond |
|
|
Term
| What are some problems with the CDS market for participants? |
|
Definition
| Reduced incentives to monitor, few banks use CDS's, 2% of loans hedged with CDS |
|
|
Term
|
Definition
| CDS priced in basis points...percentage of notional principal. At default event, pay difference between market value and par value...majority dealer to delaer |
|
|
Term
| How much was the Lehman recovery? |
|
Definition
| About 8 cents on the dollar |
|
|
Term
| How much has the CDS market changed over the decade before the crisis? |
|
Definition
| Volume of market doubled every year for the decade |
|
|
Term
| How are CDS's centrally cleared? |
|
Definition
| As of 2005, information wearhouse...central clearing tears up contract threads, reducing or eliminating market counterparty risk in "COMPRESSION TRADES" |
|
|
Term
|
Definition
| It couldnt acquire collateral to post in face of downgrades of its CDS's |
|
|
Term
| What are interest rate swap forward rate agreement? |
|
Definition
| Buyer agrees to pay contract rate. The reference (Settlement) rate is the thing to be bought or sold. Notional amount not exchanged. Buyer wants settlement>contract. |
|
|
Term
| What is the interest differential in a forward rate CDS? |
|
Definition
| Interest differential = (settlement rate - contract rate) * (days in contract period/360) * notional amount |
|
|
Term
| How is compensation determined in a forward rate CDS? |
|
Definition
| (Interest diffential)/[1 + settlement rate * (days in contract period/360) ] |
|
|
Term
| Interest rate swap exchanges are made by... |
|
Definition
| notional principal, only net interest is exchanged, usually fixed versus floating...value fluctuates with interest rates |
|
|
Term
| Why participate in an interest rate swap? |
|
Definition
| Bank versus life insurance company...bank pays floating rate on deposits tied to T-bill, insurance pays fixed rate. Can have bank pay the fixed rate to the insurance company, and insurance company pay t-bill floating rate |
|
|
Term
| Describe the market for interest rate swaps |
|
Definition
| Illiquid, with intermediaries, moved from brokers to dealers |
|
|
Term
| How do you exit an interest rate swap (IRS)? |
|
Definition
| swap reversal (enter an opposite contract, more counterparty risk), swap sale (no new counterparty risk, but original counterparty must agree), buyback/closeout (all counterparty risk cleared) |
|
|
Term
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Definition
| Option to swap. The option buyer can enter an IRS in which buyers pays fixed and receives floating, receiver is the opposite. Can be used to give bank a way to deal with default or prepayment if it needs to |
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Term
| Give an application of a swaption to the creation of a security |
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Definition
| Suppose company can't invest in equity but wants exposure to S&P. Can issue debt with option of 0 or interest tied to S&P return, then enter notional swap and pay set rate to I-bank for them to pay that interest. I-Bank gets big fees for this, remember Greece |
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Term
| How did the swaps market "blow up" |
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Definition
| ARS market failed, insurers went under, variable rates spiked. Borrowing costs skyrocketed, and required swap payments skyrocketed |
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Term
| Explain the Sewer Debt situation in Jefferson County, AL |
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Definition
| Proects itself by swapping their LIBOR-tied rate with fixed rate, insured if LIBOR goes up. Payments end up going up because failure of ARS market, and LIBOR drops due to loose monteary policy and direct FED intervention. Suspicion that Jeffco and JP Morgan knew about this, exploited tax payers for kickbacks |
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Term
| What was the LDC (less developed countries) crisis? |
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Definition
| Mexico in 1982, couldn't sevice $80 billion in dollar-denominated debt. 1983, Mexico, Brazel, Venezuela, Argentina in the hole for $239 billion (147% of capital and reserves). $37 billion owed to largest 8 US banks. |
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Term
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Definition
| Prior to '73 oil crisis, growth of 6% in LDCs, esp from oil price x4. Slowed to 4-5%, imported goods got expensive. Borrowed internationally on their growth. Debt grew 24% per year from '70-'78, with 80% sovereign. Floating rate tied to LIBOR, repriced every 6 months |
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Term
| How was the LDC crisis anticipated/realized? |
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Definition
| 1977 - Arthur Burns warns of imprudent lending, Congress held hearings since '75. second oil shock in '79, more borrowing (no run on banks). Risk shifting problems ABOUND. Bond ratings finally deteriorated in 1982. |
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Term
| How did regulators respond to LDC? |
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Definition
| INEFFECTIVELY: Warning leters, new committee, lending limits to single borrower that banks didn't follow....agencies gave up |
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Term
| How was the LDC crisis resolved? |
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Definition
| Drawn out...not until '89, regulators weren't foreful. Banks not required to put aside more capital. US gov loaned money to pay off banks to allow banks to look solvent. Final resolution was the Brady plan by Sec of Treasury |
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Term
| What was the LDC crisis resolution (Brady Plan)? |
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Definition
| Permanent reductions in principal to allow growth, funds from essentially US taxes, required economic reforms, forgave about 32% of outstanding loans, losses accrued to shareholders of banks |
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Term
| Mexican Peso Tequila crisis involved |
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Definition
| Mexico when it was doing well, in early 1990s. Optimism on reducing trade barriers with NAFTA. end of 1994, PESO value cut in half. Inflation soars, severe recession |
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Term
| What was the source of the Mexican Peso Tequila crisis? |
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Definition
| Large current account deficit peso appreciating in real terms but depreciating in nominal. Series of political shocks, uprisings, assinations. Government intervens to prop up peso , lose 11b reserves. Lots of short term debt |
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Term
| What was the US/Mexican policy response to the Tequila crisis? |
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Definition
| US raised interest rates to contain inflation, while Mexico treated as temporary shocks. Rates went up, but spread over US did not, so monetary policy not actually tight. Lost reserves were sterilized, so money supply not tightened |
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Term
| What does sterilization of reserves (i.e. in the Tequila crisis) mean? |
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Definition
| bought dollars, put out pesos...but then put the dollars back out for bonds or something. stupid. |
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Term
| What was the result of the policy changes in Mexico during the Tequila crisis? |
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Definition
| Rating went down, market reaction positive, spreads on debt had small increase, financial crisis, gov abandons exchange rate target - interest rates on repurchases jump 7.5%. Most of runs start with Mexicans, Mexico loses access to capital markets |
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Term
| What was the solution to the Tequila crisis? |
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Definition
| US rescues Mexico, 3rd largest export partner, jobs at risk. political instability, illegal immigrant/refugee problem, risk of "contagion" if US doesn't help. Mexico borrows 12.5b from US, 10b from IMF...Mexico then able to sell 1b of two yr notes at 11%, down from 20% |
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Term
| The Russian default of 1998 caused by |
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Definition
| DEVALAUATION....from negative growth rate, defense of currency - 6b in reserves. Oil/nonferrous metals prices drop, major source of foreign currency for Russia. Overall, general incompetence. Bond yields had soared, couldn't sell bonds, couldn't raise money, tax bills lowered revenue. Currency high in inflation, eventually defaults on debt. Low growth until oil prices go up. |
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Term
| What are the basic problems with sovereign debt? |
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Definition
| No bankruptcy procedure, most assets within jurisdiction of country itself, legal problems in seizing outside of country assets |
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Term
| How is sovereign debt recognized? |
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Definition
| Has sovereign immunity, is an act of state, international comity (coop with other countries) |
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Term
| What is sovereign immunity? |
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Definition
| Cannot be sued with consent, possible to waive as part of contract, stronger against collection than default. NOT absolute, laws can limit sovereign immunity for commercial acts |
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Term
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Definition
| Judge-made law, cannot be wavied, says courts should not judge validity of foreign sovereign acts, default not worthy of messing with lawmakers agendas |
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Term
| What is international comity? |
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Definition
| Keeping relations harmonious, defer to gov of country of jurisdiction in proceeding against another sovereign. Can change depending on desire of sovereign, e.g. Costa Rica case??? |
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Term
| How is sovereign debt legally enforced? |
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Definition
| Often holdout creditors trying to get better deal, not usually going to. Infrequently an issue before 1980, but after more often. Banks can influence gov for repayment/bailouts |
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Term
| What are some issues/problems with debt restructuring? |
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Definition
| Holdouts, free riding, buying debt simply to sue for it |
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Term
| So how does sovereign debt even work? |
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Definition
| Cridit protection less than corporate debt, enforcement thru future exclusion?, costly because of no consumption smoothing in response to shocks, can renogitiate often, can use insurance following default |
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Term
| What are some ways sovereign debt defaults can be punished? |
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Definition
| Syndicated lending punishing members who don't punish themselves, or can seize assets. Problem is, direct damage can hurt assets during default |
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Term
| When/why do countries actually borrow? |
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Definition
| countries borrow when doing well, contrary to smoothing hypothesis, due to capital market or political imperfections |
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Term
| When do countries actually default? |
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Definition
| Less often than expected, not after bad shocks as expected. Tend to occur in clusters |
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Term
| Are countries actually punished when they default? |
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Definition
| Capital flows decrease for 2 yrs, then return. Spreads may increase insignificantly for two years, but fall after 2 years significantly |
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