Learning Objec ves
Concept of Globalisa on and Slowbalisa on

Explain the key features which have facilitated the
globalisa on of financial markets

Refer to challenges imposed by globalisa on

Analyse measures of interna onal integra on and
their meaning
Outcome
Globalisa on is a growth of interdependence of the world’s economy, cultures
and popula ons.
(closer integra on of the countries and peoples of the world -> reduc on cost
of transporta on, communica on, + breaking down the ar ficial barriers of
goods, services, capital, knowledge).
Slowbalisa on sluggish -> capital inflow, trade growth & poli cal resistance.
Beggar-thy-neighbour policies: a country which has policy to increase their
economy but have a bad impact to the another country.

Movement of people/migra on, movement of goods and services,
movement of capital and financial flows, informa on flows.

More goods at lower prices,
Scale up businesses, be er quality and variety, innova on, job
churn, decline in gap between rich and poor globally but wider
inequality within advanced economies.

DHL Connected index -> measure the breadth and depth of
economies
Understand the unique features of global finance.

Foreign exchange risk and poli cal risks

Market imperfec ons

Expanded opportunity set

Maximise the wealth of shareholders,

maintain the rela onship among stakeholders

Diminishing the principal agent conflict

Maintain the climate of business culture

Emergence of Globalized Financial Markets

Emergence of the Euro as a Global Currency

Europe’s Sovereign Debt Crisis of 2010

Trade Liberaliza on and Economic Integra on

Priva za on

Global Financial Crisis of 2008-2009
Many MNCs obtain raw materials from one
na on, financial capital from anothis/, produce
goods with labor and capital equipment in a third
country, and sell their output in various other
na onal markets
What are the goals of interna onal financial management?
Discuss the current trends and developments.
Understand the contribu on of MNCs to globalisa on.
Learning Objec ves
Confirm the understanding of key terms used in global
financial markets and interna onal finance from the
perspec ve of na onal accounts:

Components of the Balance of Payment and
Interna onal Investment Posi on

Using mainly USA and Australia as a case study
Outcome
Balance of Payment is a sta s cal records of country’s transac on with the
rest of the world over the certain period of me presented in the form of
double entry bookkeeping.

The current account (TB+IB), the capital account, official reserves
account, sta s cal discrepancy (plug to balance)
BCA + BKA + BRA = 0
Dis nguish between different types of capital flows and
discuss their recent
Development

Foreign direct investment (FDI)

Foreign purchases of equity

Foreign purchases of debt securi es

Lending and other investment
Net Interna onal Investment Posi on (NIIP) is the difference between
country’s ownership of financial assets and its financial liabili es to foreign
residents.
SWF -> government-controlled investment funds to establish/being visible role
in intl investment.

Current account balances
Financed by either selling assets to foreigner or borrowing
Current account surplus => earning more than spending =>
country can lend to rest of world and/or repay debt

Valua on changes of financial securi es

Exchange rate fluctua ons
Deprecia on => foreign assets worth more measured in
domes c currency while foreign liabili es (measured in
domes c currency) do not change => NIIP improves.
Vice versa for Apprecia on
Rela onship between CA and changes in NIIP: Posi ve (Nega ve) CA in one
year implies posi ve (Nega ve) growth of the NIIP of a country in that year,
which means that the country is using its excess savings in that year (in excess
of investment) to buy (sell) more foreign assets. Also Nega ve CA means
foreigners are buying more assets in the country and by doing this they are
lending to the country
Global imbalances: persistent surpluses in some
countries in conjunc on with persistent deficits in
other countries
Study the factors which affect NIIP
Learning Objec ves
Governance and the
Public Corpora on: Key
Issues
The Agency Problem
Remedies for the Agency
Problem
Law and Corporate
Governance
Consequences of Law
Corporate Governance
Reforms
Outcome
Corporate Governance: The economic, legal, and ins tu onal framework in which corporate control and cash
flow rights are distributed among shareholders, managers, and other stakeholders of the company.
1. To protect shareholders rights
2. Curb managerial excesses
3. Restore confidence in capital markets
Key Issues:

Public corpora on -> major organiza onal innova on

Efficient risk sharing mechanism to raise of capital.

Conflict of interest between managers and shareholders

Diffused ownership->low incen ves to monitor management performance. (easy to walk-out from
stock ownership)

Majority vs minority ownership
Short-term control of the firm->managers act based on their short-term interest >< shareholders long-term
interest.

FCF

Managerial Entrenchment

Empire building incen ves

Managerial incen ves to invest in – NPV projects

Firm size and compensa on

Firm size and pres ge/ego

Reputa on

Independent BoD
o (Germany)Corporate Boards represent interest of stakeholders
o (England) 3 outside directors + board chairman ≠ CEO
o (Japan) keiretsu (family ownership)
o (Korea) Chaebols (family ownership)

Incen ves contract, difficult since accoun ng based are subject to manipula on

Concentrated ownership

Accoun ng transparency

Debt issuance -> bond holder monitor the company to ensure the payment.

Dividends

Overseas stock lis ng -> increase investor protec on

The Market for corporate control -> law of investor protec on based in the country they listed.

Invi ng hos le takeover bids.
Investor protec on based country legal system

English common law

French civil law

The pa ern of corporate ownership and valua on

Development of capital markets

Economic Growth

Ownership and control -> pyramidal ownership structure

Capital markets and valua on -> if assured being paid fairly, so the investor willingness to pay more
securi es increased.

Economic growth -> funds available for investment at low cost

Strengthen the protec on of outside investors from expropria on by managers and controlling
insiders
o Sarbanes-Oxley Act
o The Cadbury Code
o The Dodd-Frank Act

Corporate governance reform efforts should be focused on how to be er protect outside investors
from expropria on by controlling insiders. O en, controlling insiders resist reform efforts, as they do
not like to lose their private benefits of control.
Learning Objec ves
Understand what
Central Banks do
Understand yields
and the yield curve in
the context of finance
and macroeconomics
Be able to explain
what unconven onal
monetary policy and
QE are
Be able to describe
the main financial
intermediaries, their
differences, and their
roles
Output
The main role of central banks is to set monetary policy, to meet objec ves declared in its statute

Moving short term policy rates

Trying to control the yield curve, i.e. both short-term and long-term rates
Other important central bank func ons include:
• Supervision of the banking system (some mes other ins tu on)
• issue of bank notes
• ac ng as the banker to other banks
• ac ng as banker to the government
• raising money for the government
• controlling the na ons currency reserves
• ac ng as the lender of last resort
• liaison with the interna onal bodies.

A bond's coupon rate is the rate of interest it pays annually, while its yield is the rate of return it
generates rela ve to investment.

The term structure of interest rates is the rela onship between bond yields and different terms or
maturi es.

The term structure of interest rates is also known as a yield curve, and it plays a central role in an
economy.

The yield curve is created by plo ng US government bond yields of different maturi es on a single graph,
with the yield on the shortest maturity (say 1 month treasury bills) at one end and the 30-year “long”
Treasury bond (say 30 year) at the other.

The short maturity treasury bill is normally very close to the central bank policy rate

Shorter maturi es normally carry lower yields because “stuff can happen” between the shortest maturity
and later maturi es and investors want compensa on for the risk.

If there is a big difference between short- and long-term Treasury yields — that is, if there is a steep
upward curve — then it suggests that investors expect infla on and interest rates to rise markedly in the
future.

But as that difference declines — as the curve fla ens — it indicates that investors expect slower infla on
and more tepid economic growth in the future. Ini ally, this may not be a terrible thing. The Fed typically
raises interest rates when the economy is doing well and infla on is rising. By increasing short-term
yields, the premium for inves ng in longer-dated yields declines.

What investors do not want to see is a nega ve, or “inverted”, yield curve — one that, on a graph, has a
downward kink. That suggests that an economic slowdown may be approaching, one in which infla on
will fall and the Fed will have to cut rates.

Inverted yield curve happens by the reason in the beginning that the infla on rate grows and the
regulator need to maintain in safe level due to the low interest rate policy to boost the economy. That
means the investor expect the higher yields in the future, since it will boost the infla on rate if the
demand is exceed the supply of goods and labor. The central bank begins to increase the interest rate, in
order to limit the supply of money. By then the yield curve begin to fla en, and since it happens, the
economic is slowing down. In this me, the investor seems to panic, as the short-term interest rate is
higher than the long term. The investor such as pension fund begin to rebalancing the investment in
treasury bonds to matching the rates they expect put into the long term to lock the rates. They will also
expect in the central bank will cut the interest rate. So the demand of the long-term bond going up and
as there is the inverse rela onship between prices of bonds and yields -> the price is going up as well &
lower yields. The exteme condi on is drive the yield of long-term bonds below the short-term yield so it
will influence yield curve into inverted and spooked the investor.

The yield curve move as investor expecta on & monetary policies establish by the central banks.
Conven onal monetary policy is widely used before the GFC as the central bank would only focus to move the short
end, by altering the policy rate.
Unconven onal monetary policy is the central banks try to control the yield curve which means a combina on to
control the short-term policy rate as well as movement in the long-term rate.
Quan ta ve Easing is the central bank policy to purchase long-term securi es, as helping to s mulate the economy
by lowering the long-term rates. The decreasing of treasury and GSE securi es supply influence the investor to buy
the another assets.

Banks – An ins tu on that pooling the money from people as savings and redistribute the wealth as form
of loans for the borrowers to trigger the growth of economy.
o classic bank
o investment bank -> raising debt and equity financing for corpora ons and governments.

Insurance companies -> risk bearers in return for premiums.

Pension funds -> establish the payment of re rement benefit.

Investment companies -> financial intermediaries that sells shares to public and inves ng in the
diversified por olio of securi es.

Hedge funds -> hedge funds pool investors’ money and invest money in an effort to make a posi ve
return. It is quite different with the mutual funds since they have more flexibility.
Learning objec ves
Understand “Current
Global Bond markets
Post GFC” and connect
the situa on to the
lecture topics
Analyse the main
elements of
the Money
Markets
the Corporate
Bond market
the Euro Bond
market: origin
and features.
the US Bond
markets
The Australian
market, including
Kangaroo
issuances
Being able to link the
effects of domes c
regulatory provisions on
foreign borrowers and
the development of
markets.
Analyse High Yield Bonds
Understand the
terminology
Output
Flight to quality -> investor became more risk-averse and demanded higher returns for holding risky assets, while
accep ng lower or even nega ve yields for holding safe assets.

Corporate bond issues has increased significantly.

Higher demand for junk bonds

Also central banks lowered interest rates => bond yields plummeted to historic lows

Inverted yield curve -> CB started hiking the interest rate.
How investors buy bonds: (1) at issuance (less frequent) or (2) on the secondary market a er
they’ve been issued

The nominal interest (i) is pre-set at issuance but then prices fluctuate daily etc., depending on the valua on of the
bond.

The yield is the amount of return that an investor will realize on a bond.

With fixed i and fluctua ng P, the yield fluctuates too
Bonds with nega ve interest rates?

Bond prices move in the opposite direc on to rates, so nega ve yields are another way to say that the prices of these
bonds have risen really, really high
o
That reflects anxiety among investors, who are willing to lock in a small loss on their money rather than risk
the chance of something worse by pu ng their cash into other assets.
Current concerns in the market is:

Bond prices falling

High yields on bonds

High vola lity in the bonds market

Wildly illiquid markets

Flight to safe-haven government debt

High yields on corporate bonds.

MM: have a maturity of short-term (1Y or less), - Discount securi es
o
T-bills
o
Bank bills
o
Commercial paper

Corp bond market: issued by corp to raise money to expand their business. Longer-term debt instrument
o
Secured debt vs unsecured debt
o
Senior debt vs subordinated/junior debt
o
Zero coupon bonds
o
Perpetual bonds

Eurobond: External bond market = interna onal, offshore, Eurobond
o
Bonds in this market are underwri en by an interna onal syndicate
o
Offered simultaneously to investors in a number of countries at issuance
o
Issued outside the jurisdic on of any single country, therefore not registered though a regulatory agency
o
In an unregistered form

Eurobond Features
o
High of credit ra ngs
o
Some as part of swap deals
o
Common form is straights -> pay fixed rates of interest and repayment of principal upon maturity.
o
Medium-term borrowing market
o
Call protec on
o
Sinking fund or compulsory securi es re rement
US debt markets are ghtly regulated.
Kangaroo issuers play an important role in the cross-currency swap market because, by conver ng the Australian dollars they
raise into foreign currency, they act as indirect counterpar es for Australian corpora ons looking to convert funds raised offshore
into Australian dollars.
If a foreign borrower raises funds in an interna onal financial market, it must observe
the laws of that market (usually, unless they are able to legally allow the laws of another
country – termed “the governing law” - to apply).
Foreign Bonds markets – subject to the domes c regula on of the country where the
issue is made. These foreign laws have, in part, influenced the form of overseas
borrowings, par cularly in the Yankee market

A high paying bond with a lower credit ra ng than investment-grade corporate bonds, Treasury bonds and municipal
bonds. Because of the higher risk of default, these bonds pay a higher yield than investment grade bonds.

All "junk" connota ons aside, high-yield bonds are widely held by investors worldwide, although most par cipate
through the use of mutual funds or exchange-traded funds. The yield spread between investment grade and high-yield
will fluctuate over me, depending on the state of the economy, as well as company and sector-specific events.

Bond Proceeds can turn into different types of capital flows: FDI Debt, trade credit, loans, deposits.

Interna onal bond issuance, cross-currency swaps, and capital flows

Learning objec ves
Credit Ra ngs Background
– What credit
ra ngs are, and are
not
– Historical
Performance
– Who uses them,
and why?
Determina on of
Credit Ra ngs
Who Issues Credit
Ra ngs?
Pa erns of Default
Credit Ra ngs and
Financial Crisis of
2007—2010
– Case Study: US
Sub Prime
Mortgage Debt
– Lessons Learned
from the Crisis
Output
What credit ra ngs are, and are not

Opinion in forward looking about rela ve risk, ability and willingness to meet financial obliga ons in full
and on me

Globally consistent credit benchmarks, comparable across different sectors and regions

Are not:  Indica ons of market liquidity or price  Guarantees of credit quality or future credit risk 
Absolute measures of default probability  Expected ul mate loss given default*
Historical Performance

Over me going on, the default rates is increase subject to the ra ng level.

Investment grade ra ngs, tend to have a very low rate of default risk.

Specula ve ra ngs have higher default rates. (exponen al)

While the market is tend to more risk averse, the yield differences is increasing

Lower rate securi es need to pay higher yield depending on monetary condi on, risk appe te, and
alterna ve asses.
Who uses them and why?

Intermediaries (Bankers)
Benchmarks: Ra ngs help banks price a transac on by comparing it to other similarly rated deals

Issuers (Borrowers)
• An cipate cost of debt.
• Access a wider group of investors
• Compare with others

Investors (Lenders)
• Can benchmark issuers against other issuers
• Supplements in-house credit resources
1. Ra ngs request from issuer
2. Ini al evalua on
3. Mee ng with the issuer management
4. Analysis
5. Ra ng commi ee review and vote
6. No fica on to issuer
7. Publica on & dissemina on of public ra ng opinions
8. Surveilance of rated issuers and issues, back to step 5.
Credit Ra ng Agencies are mostly privately owned companies that charge fees for assigning ra ngs and also sell
subscrip ons to their published reports.

S&P Global ra ngs

Moody’s Investor services

Fitch ra ngs

Local Ra ng: R&I, JCR, ChengXing, Lianhe, Dagong, Shanghai Briliance, ChungHwa, Crisil, Icra, RAM, Marc,
Dominion Bond ra ng, NICE, KIS, Fiin Ra ngs, Pefindo.
Creditworthiness deteriora on, is not commonly gradually decrease over me, unfortunately such as bank industry
which is some mes are rated as investment grade but by the leverage characteris c it some mes vulnerable to the
economic condi on so the probability of being default some mes happen as fall from the cliffs.
It is quite similarly with the other industry, some corporate has a stage of creditworthiness deteriora on. A company
may have a downstage of credit ra ngs and stay in a quite long period of specula ve grade before it going to be
default.

Default studies have historically shown a strong correla on between ra ngs and default frequencies

Global corporate and sovereign ra ngs, European structured finance and US ABS ra ngs, have generally
performed well

As the level of credit ra ng lower, the number of companies being default is increase as well as the number
of member in the credit ra ng level is increasing. Unfortunately as example Lehman Brothers which is in
investment grade, about AA level, is 1 of 5 companies which is default, so as investment manager we
should take a look into the diversifica on opportuni es since we’ll not sure if we invest in investment grade
just one company, may be that company is probable being default.

Credit buffer In general, is a reserve of funds that a financial ins tu on sets aside to absorb poten al losses
from bad loans or other credit-related risks

In the case of subprime lending, which refers to the prac ce of lending money to borrowers with poor
credit histories, credit buffers are par cularly important because the risk of default is higher

If a financial ins tu on does not have a sufficient credit buffer to absorb the losses from subprime loans, it
may be forced to reduce lending or even go out of business.

In the context of subprime lending, cumula ve credit losses can be significant if a large number of
borrowers default on their loans
Learning objec ves
Iden fy the most important trends in
Interna onal Equity markets



Understand
– the factors affec ng global financing
– Cross Lis ng and its benefits
– Cross Lis ng in the US
Be able to explain
– the func ons of American Depository
Receipt (ADR)
– types of ADR
– Global Depository Receipt (GDR)
– Global Registered Shares (GRS)
Discuss cri cally the reasons of de-lis ng in
the United States
Output
Liquidity
The market capitaliza on-to-GDP ra o is a financial metric used to evaluate whether a
given market is undervalued or overvalued compared to its historical average.
China and india is expec ng that the market cap will be growth and exceed the Europe
and will compete with the U.S.
Today, stock markets around the world are under pressure from clients to combine or
buy stakes in one another to trade shares of companies anywhere, at a faster pace
The factors affec ng global financing

Interna onal diversifica on become beneficial

Compe ve cost of commission and more liberalized so there is a reduc on in
government regula on.

Technology advancement made transac on more efficient and fair.

Benefit of accessing interna onal market to get source of funds.

FTA increase the benefit of trading.
Cross lis ng

Cross lis ng is a company's common shares on a different exchange other than its
primary and original stock exchange

Dual lis ng occurs when two or more companies (each listed on a separate stock
exchange) agree to combine their opera ons and cash flows (merger) but retain
separate share registries and iden es
Benefit of cross lis ng

Improved liquidity

Raising capital

Increasing the firms visibility to poten al customers, suppliers, and creditors.

Informa on quality

Investor protec on

Cost of capital benefits
Cross-lis ng in the US
Sarbanex-Oxley (SOX) -> is a United States federal law that set new or expanded requirements
for all U.S. public company boards, management and public accoun ng firms. Some provisions
also apply to privately held companies.
Cross lis ng type: Depository receipt program & direct share lis ng.
Depository receipt program
Nego able cer ficates issued by a bank to represent the underlying shares of
stock, which are held in trust at a foreign custodian bank.
It represents ownership of equity shares in a foreign company.

American Depository Receipt (ADR): arrangement by which foreign companies cross
list on U.S. exchanges. Type of ADR is sponsored vs unsponsored ADR.

GDR is arrangement by which foreign companies (including U.S. companies) cross
list on foreign exchanges, other than U.S. exchanges.

GRS is Shares traded globally with same price in different currencies
Role of depository bank

Depository

Transfer agent -> act as proxy agent: sends out proxy materials and acts as an
intermediary between shareholders and the company. Proxy agents also run annual
mee ngs as inspector of elec ons, proxy vo ng, and special mee ngs of
shareholders.

Administrator
Cross-lis ng in the US
Sarbanex-Oxley (SOX) -> is a United States federal law that set new or expanded requirements
for all U.S. public company boards, management and public accoun ng firms. Some provisions
also apply to privately held companies.
It affect to the increase of lis ng fee/cost of cross lis ng in the US -> compliance cost (sec on
404) -> less a rac ve.
So it influence specific to the U.S. lis ng which is lis ng gap -> delis ng
Learning objec ves
Understand and discuss the role played by
deriva ves markets (exchange traded and
OTC)
Be able to describe different deriva ve
contracts: Forwards and Futures, Op ons,
Swaps,
(Credit deriva ves – later in the course)
Explain and understand the
func on/opera ons and importance of the
OTC markets.
The OTC markets Pre-GFC
Deriva ves and the GFC
Post-GFC Changes to the OTC market
What are the benefits that CCP is actually
providing to markets
Discuss the changes in regula ons rela ng
to CCPs
Output
Financial assets which derives its price from the asset underlying the contract.
Exchange traded deriva ve contract are standardized deriva ve contract that are transacted
on a formal organiza on futures exchange.
OTC deriva ves are a contract that are traded directly between par es without going through
exchange or intermediaries.
Benefit of deriva ves:

Risk protec on with minimal upfront investment and capital consump on

Trade on future price expecta on

Very low total transac on cost than invest directly in underlying assets

Fast product innova on

Able to customize depend on the needs.
Futures: Contract entered today which has agreement of price today to buy or sell in the
future. -> The central clearing house is the opposite party to each transac on
Op ons: Contract entered today at a price agreed today to have the op on to exercise the
price to buy/sell in the future. -> The central clearing house is the opposite party to each
transac on
Swap: a type of OTC deriva ves which contract nego ated each party and subject their users
to the risk of counterparty default.
the risk transfers and cash flows in a swap:

The cash flows exchanged between the par es in a swap are based on the no onal
principal amount, which is the hypothe cal amount of the underlying asset being
exchanged

The purpose of a swap is to transfer risk from one party to another.
The OTC deriva ve market is the largest market for deriva ves, and is largely unregulated with
respect to disclosure of informa on between the par es, since the OTC market is made
up of banks and other highly sophis cated par es, such as hedge funds.

OTC-Cleared deriva ves growth substan ally in the energy deriva ves.

Introduced the clearing solu ons

Since then the growth being steady

CDS and other OTC deriva ves contract required to post more collateral if its own
credit ra ng fell.

Increasing the liquidity stress

a solu on to the credit crisis precipitated by CDSs
CCP effec vely guarantee the obliga ons under the contract of the counterparty.
Reducing the complexity of web bilateral exposure
(1) Mul lateral ne ng
(2) Manage defaults
Improved overall transparency
Be er market-to-market pricing
More efficient OTC deriva ves market
Ability to execute trades through a greater list of counterpar es
Standardiza on of Credit Support Annex
Preven on of uncollateralized posi ons
G20 Commitment

Fair and open access

Co-opera ve oversight arrangements

Resolu on and recovery regimes

Appropriate liquidity arrangement
Learning objec ves
Concept of securi sa on
Process of securi za on
Define the risk factor
General Understanding of the regulatory
provisions
Proper es of ABS, MBS, CDO and CLO
Covered bonds
Assess the current state of the market,
with a focus on CLOs and MBS
Output
pooling & repackaging of rela vely homogenous assets
into securi es
The essen al features of securi za on are: 1. The sale proceeds are available to the
Originator of the transac on (i.e. the seller) immediately; 2. The assets are taken off the
Originator’s books and are not available to the Originator’s creditors in the event of his
bankruptcy; 3. Can have higher credit ra ngs than the Originator’s, depending on the quality
of assets securi sed and credit enhancements made available.
Asset 1,2,3 -> SPV ->
1. Senior tranche
2. Mezzanine tranche
3. Equity tranche

Payment risk

Interest rate exposure

Credit risk reoval

Reduc on of concentra on risk

Prepayment risk

Securi sa on, as a part of the shadow banking agenda, con nues to be a key focus of
interna onal reform work being driven by the G20 and FSB
IOSCO published its report on global developments in securi sa on regula on.
The report made several recommenda ons in rela on to:
– Incen ve alignment and risk reten on
– Transparency and standardiza on.
Basel Commi ee on Banking Supervision released the revisions to the Securi za on
Framework which aims to address a number of shortcomings in the exis ng securi sa on
framework and to strengthen the capital standards for securi sa on exposures held in the
banking book.
Asset backed securi es
Mortgage backed securi es
Collateral debt obliga on
Collateral loan obliga on
The key difference between covered bonds and CDO or asset-backed securi es is that banks
that make loans and package them into covered bonds keep those loans on their books.
Peer Review Undertaken and concerns from Investors about what was dampening the
appe te for securi sa on, include:
The first was uncertainty about the form regula on was taking. - - Only 5 out of 24 FSB
jurisdic ons had fully implemented incen ve alignment and related disclosure measures
across all sectors.
- The second was concern about the full impact of regula on – capital requirements and
disclosure requirements
- The third was concern about the uneven playing field across comparable asset classes and
between jurisdic ons. This is a par cular issue in Europe – and some other jurisdic ons –
where covered bonds are subject to lighter regulatory and capital requirements than
securi sa ons. It also remains
an issue in rela on to cross-border issuances. Most jurisdic ons had not considered the
impacts on cross-border issuance and investment when se ng their regulatory framework in
place.
Learning objec ves
Review basic credit deriva ve structures
– Total return swaps
– Credit Default Swaps
– Collateralised Debt Obliga ons
Output
Deriva ves where the payoff depends on the credit quality of a company or sovereign en ty

Total Return Swaps
one party pays a fixed set of payments in return for a variable stream indexed to the total
return (coupon plus value change) of the reference bond

Credit default swap
one party receives a fixed income stream in return for the promise to pay a pre-arranged lump
sum in the event of default of the reference bond -> Premium is known as the credit default
spread. It is paid for life of contract or un l default. + You do not have to hold the underlying
asset to buy a credit default swap. -> you only receive payment from a credit default swap in
the case of an actual default

CDO -> CLO and CBO
synthe c CDOs gain credit exposure to a por olio of fixed-income assets through
the use of credit default swaps. The risk of loss on synthe c CDOs is divided into
tranches just like tradi onal (cash) CDOs

Forwards and op ons on CDS -> par cular CDS/En ty
Work through the SEC versus Goldman
Sachs Abacus case
– Aim is to understand some of the
complexity and the ethical issues involved
– What would you have done in the same
situa on?
The SEC versus Goldman Sachs Abacus case was a highly publicized case that involved
allega ons of securi es fraud against Goldman Sachs 1. The case centered around a complex
financial instrument called the ABACUS CDO, which was created by Goldman Sachs and sold
to investors in 2007 1. The SEC alleged that Goldman Sachs made materially misleading
statements and omissions in connec on with the ABACUS CDO placement 2.
The case raised several ethical issues, including conflicts of interest, transparency, and
disclosure. For example, the SEC alleged that Goldman Sachs misled investors by failing to
disclose that a hedge fund, Paulson & Co., had played a significant role in selec ng the
underlying securi es for the ABACUS CDO and had bet against the securi es 3. This created a
conflict of interest because Goldman Sachs was marke ng the ABACUS CDO to investors while
Paulson & Co. was be ng against it 3.
In addi on, the case raised ques ons about the transparency and disclosure of complex
financial instruments such as the ABACUS CDO. Some cri cs argued that these instruments
were too complex for investors to fully understand their poten al downside risks 1.
If I were in the same situa on, I would priori ze transparency and disclosure to ensure that
investors have access to all relevant informa on before making investment decisions. I would
also ensure that there are no conflicts of interest that could compromise the integrity of the
investment process. Finally, I would work to ensure that complex financial instruments are
properly understood by investors and that they are not marketed in a way that misleads
investors about their poten al risks and rewards.
Learning objec ves
The build up to the GFC
What happened in the US that led to the
Subprime crisis
What are the causes and catalyst of the
GFC
Risk manifested in the GFC
Ethical Issues in the GFC
Interna onal Spill-overs and Lessons/Policy
Responses drawn from the GFC – to
Australia
Where are we at post GFC
Economic implica ons of COVID-19 crisis
Output
Global saving glut -> excess of saving + surplus of Current account lead to the low
interest rate and large capital inflows -> + the financial ins tu on innova on as the
originate-to-distribute which is bank make a loan and develop a securi za on of that
loan. (so loan is distributed)-> no-skin-in-the-game is no incen ves to hold the risk.

The managers of the bank is begin to asses their performance based on the disburse
of loan volume rather than long-term profitability. -> liquidity shortages.

High liquidity => overconfidence => managers more likely to underprice loans => Asset
price booms => bust so Crisis

High macro risk => Flight to safety => Banks experience influx of liquidity => Bubbles
and Crisis
Low interest rate-> originator relaxed the lending standard + crea ng large subprime mortgage > demand of housing increase->objec ve to a ract the first me buyers, relaxed lending
standard+featured of lending scheme -> bank create securi za on to raise capital -> FI &
government invest it as the credit ra ng is AAA (since it backed up by physical asset ->
mortgage) so the promised return is higher with the low cost of fund -> house pricing bubble
bust & lot of borrower unable to pay the obliga on -> sell off-> the house price decrease->
securi za on of mortgage is being risky -> capital flight into higher quality.
1. The growth of inequality
2. The development and use of new financial instrument
3. Low interest rates, cheap loans, and rising leverage of investments
4. Light government regula on in parts of the financial sector and absent in other
5. Ethics, and inadequate governance, accountability, remunera on prac ces in financial
ins tu ons

Credit risk

This risk had been passed on through various structures in the market

High leverage

Liquidity risk

Concentra on risk
Responsibility and ethics

Mortgage Brokers -> high commission + costly loans

Ex Ci CEO Charles -> enjoying the situa on/looking the benefit

Subprime mortgage lenders -> lack of financial sophis ca on & not full disclose the
ability to pay and risk may be arise

Securi za on of mortgages -> failed to disclose the informa on needed + very
complex product

Ra ng agencies: bias as they paid by the client to asses the ra ngs.

Regulatory agencies: ban mortgage loan prac ces it found to be unfair or decep ve

AIG: necessary to provide any type of reserve for losses on its credit default swaps

Commercial and investment banks: high level of leverage- Leverage is a very risky
strategy- + he banks had li le or no cushion when the financial crisis unfolded

OTC deriva ves: exempt OTC deriva ves from regula on, cons tutes ethical
government policy.

common elements are high leverage with large short-term borrowings, predominantly
long-term illiquid investments, and complex financial structures including intraconglomerate equity cross-holdings and debts.

Short selling, margin lending, securi es lending prac ces, and financial advisory
prac ces all came under scru ny in the prolonged bear market, and exposed
regulatory weaknesses.

• Collapse of major firms’ stock prices;

• Superannua on and pension fund returns were badly affected.

The economic climate is not the same – “Debt fears to temper interest rate rises”

Interest rates increasing. Fears of defaults.

Australia’s first recession in nearly 30 years

GDP shrank 0.3% in the 1st quarter and 7% in the 2nd quarter of 2020

For comparison, 2nd quarter GDP change recession in several developed and
emerging market
