...pResented by the society of ActuARies, the cAsuAlty ActuARiAl society And the cAnAdiAn institute of ActuARies Risk Management: The Current Financial Crisis, Lessons Learned and Future Implications Copyright 2008 by the Society of Actuaries. R I s k M a n a g e M e n T: the current financial crisis, lessons learned and future implications introduction the current financial crisis presents a case study of a “financial tsunami” (as former federal Reserve chairman Alan Greenspan recently called it) on what can go wrong. its ramifications are far-reaching and the lessons learned will be embedded in risk management practices for years to come. As one of the premier enterprise risk professions in practice today, the actuarial profession is sharing its substantial insight into what went wrong and the implications for the future. on behalf of the society of Actuaries, the casualty Actuarial society and the canadian institute of Actuaries, we are pleased to provide a series of essays on Risk Management: The Current Financial Crisis, Lessons Learned and Future Implications. this e-book is the result of a call for essays on the subject coordinated by the following groups: • • • • The Joint Risk Management Section of the Society of Actuaries, Casualty Actuarial Society and Canadian institute of Actuaries The Investment Section of the Society of Actuaries International Network of Actuarial Risk Managers Enterprise Risk Management Institute International ...
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...finance is important to all managers due to the priority capital has in a company. That is, without effective financial management, a company will be unable to develop products, get them to market and grow the business. Organizational forms a company may have as it evolves from start up to major corporation are: Sole Propietorship. Effectively a person “hangs a shingle” and becomes a business. It is subject to few government regulations and income is taxes as the proprietor’s personal income. However, its structure makes it difficult to generate growth capital, the proprietor has unlimited personal liability for company debts and the company only lives as long as the propietor. Partnership: This can take the form of a limited partnership and a general partnership where liability and control is divided along these lines. A limited liability partnership or limited liability company is structured to where all partners have limited liability with respect to the business’s liabilities. This works well for the partners but is an area of concern for the partnerships lenders, customers and suppliers. Corporation: This is created as a separate legal entity under law and as such is “separate and distinct” from its owners and managers. The advantages are is has unlimited life and can continue after the death of the owners. It also has easy transferability of ownership interest through transfer and sale of shares of the company and limited liability. That is, the liability is limited...
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...Table of Contents Problems with AIG and Credit Default Swaps 1 Financial Crisis 1 Why study AIG case 1 Define what a CDS is and history of AIG 2 AIG background 2 What are Credit default swaps? 3 What happened at AIG? 5 Why is the AIG case so special? 7 Government Reactions 8 Expert Opinion 10 Causes, How it can be Solved, Possible Ways it Can be Prevented 11 Works Cited 14 “Financial derivative products were financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." -Warren Buffett Problems with AIG and Credit Default Swaps Financial Crisis: Credit derivatives are believed to be one of the primary causes behind the financial crisis in 2008, and they continue to be an existing threat to the global economy in the future. Many economists have indicated that the breakdown in the credit derivatives market was the main reason behind the collapse of large corporations like Lehman brothers and AIG, as opposed to the subprime mortgage market. Why study AIG case: The failure of AIG can be primarily attributed to greed. Like many other insurance companies, AIG was too risky on credit default swaps. By the time of the crisis, the company had written more than $441 billion in swaps on bonds and securities, including mortgage-related securities. The collapse of the mortgage market unveiled the problems of credit derivative products and drew widespread attention to this huge and dangerous market. American International...
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... Abstract The Tech Bubble Introduction Lowering of Interest Rates Adjustable Rate Mortgage Securitization Mortgage Backed Securities Collateralized Debt Obligation Credit Default Swap Government Reaction and Policies Emergency TARP Repercussions Basel Disadvantages Future Policy Requirements Controversy Conclusion Reference List Review of the causes of the 2008 Financial Crisis in US. Abstract This paper seeks to summarize a stream of research that has delved into the major causes of the financial crisis in 2008. More precisely, we will be looking at a combination of causes such as the sub-prime mortgage crisis, the mortgage backed security, the collateralized debt obligation as well as how the incidental credit-default swap contributed to the incident. This paper will begin from analyzing the past, when it happened and how it built up and resulted in the financial crisis. The significance of this literature review seeks to give a simplified explanation of the financial crisis of 2008 and will be useful for the people unversed in economics or finance but wish to have a basic understanding of its causes and history. The Tech Bubble During the early 2000, numerous companies and individuals bought new operating systems that were Y2K-ready in fear that the “Y2K” problem would cause computer systems to malfunction. This had allowed technology companies to generate obscene amounts of revenue. At one point, the telecommunications giant, Nortel...
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...of the economy; without banks, the economy will not function properly. Why? The answer is that banks provide the link between savers and borrowers. In the US, people are net savers and businesses are net borrowers. Without banks and some other financial institutions, the borrowers, businesses, will not be able to raise finds by borrowing from people, the savers. This function takes many forms. We will look at some if these forms in this course and in other courses in the finance concentration in the MBA program. The Nature of Banking in the US See Chapter 1 in the Textbook With a population of 30 million, Canada has 11 banks; Britten has 4 or 5 banks to serve 60 million citizens. Other countries have similar ratio of banks to population; about 3 to 6 million to a bank. How many banks does the US have to serve 300 million in population? The US has about 7,500 banks; this number does not include other companies that provide banking...
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...credit derivative which its function is like insurance contract between two counterparties on one or more companies' loan or bond. One party who buys the protection called "protection buyer" has to pay a periodic premium to another party called "protection seller" until expiry of the contract, in return for protection against a credit event (financial difficulty such as bankruptcy, failure to pay or restructuring) of a known reference entity (company). The protection buyer receives protection in form of the right to sell bonds issued by a particular company for their face value or receives principal amount of loan if the company defaults. An example from the case, Charles Bank International (CBI) wanted to lend $50 million to CapEx Unlimited (CEU) company. However, if the amount was lend to CEU, the bank would have high risk exposure to the company and the risk exceeded CBI's risk guidelines. Thus, CBI bought a CDS on CEU company from First American Bank (FAB), these method would mitigate the extra credit risk for CBI from the new $50 million loan. CBI had to pay a periodic fee to FAB until the CDS expired. In this case, if CEU company defaulted before the contract expired, FAB would pay the principal loan amount. The settlement in the event of default involves either "physical delivery" or "cash payment". In the physically settlement, CBI would deliver the CEU's loan to FAB. Then FAB would pay CBI the loan amount which in this case was $50 million. In the cash settlement, FAB...
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...authorization t ct, r en f or through payment of th appropriate pe he er-copy fee to th Copyright Cle he earance Center, I Inc., 222 Rosewo Drive, ood Danvers, MA 01923, website www.copyright A e t.com. Requests to the Publisher for permission should be r addressed to t Permissions Department, Joh Wiley & Son Inc., 111 Rive Street, Hobok NJ 07030the hn ns, er ken, 5774, (201)74 48-6011, fax (20 01)748-6008, we ebsite http://www w.wiley.com/go/ /permissions. To order book or for custom service, pleas call 1(800)-CA ks mer se ALL-WILEY (2 225-5945). Printed in the United States of America. e o ISBN 978- 0-470-56516-2 The Financial Crisis: 2007-2009 Objectives Understand the major influences that led to the 2007 2009 Financial Crises Describe the role that agency cost issues played in the financing of mortgages to developing mortgage backed securities and other financially engineered securities based on mortgages Describe the timeline of events that unfolded during the financial crisis Explain how financial managers must consider the risk, not only the return potential, of their activities Discuss the role of government intervention in the context of economy theory and practice INTRODUCTION How did the...
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...standard deviation eclipses do not, and have not, occurred at the interval statistical quants have modeled. In fact the anomaly is to believe that Black Swan events are anything but a force of nature and occur about as common, as frequent and as necessary as the changing of the seasons. The “Follow Through Plan”, needed to retain economic leadership of the United States well into the 21st century, should include all of the following critical levels of change and direction. The order iterated is roughly paramount to its relative importance; however some of the quantum policy shifts have been deferred to the end of this dialogue even though their importance and measure of affect are considerably greater than the former tenets of the Plan. 1) The Stimulus Package The key focus of any Stimulus Package needs to center on three central themes; • Infrastructure;...
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...Lewicki−Barry−Saunders: Negotiation: Readings, Exercises, and Cases, Fifth Edition Cases 1. Capital Mortgage Insurance Corporation (A) © The McGraw−Hill Companies, 2007 Case 1 Capital Mortgage Insurance Corporation (A) Frank Randall hung up the telephone, leaned across his desk, and fixed a cold stare at Jim Dolan. OK, Jim. They’ve agreed to a meeting. We’ve got three days to resolve this thing. The question is, what approach should we take? How do we get them to accept our offer? Randall, president of Capital Mortgage Insurance Corporation (CMI), had called Dolan, his senior vice president and treasurer, into his office to help him plan their strategy for completing the acquisition of Corporate Transfer Services (CTS). The two men had begun informal discussions with the principal stockholders of the small employee relocation services company some four months earlier. Now, in late May 1979, they were developing the terms of a formal purchase offer and plotting their strategy for the final negotiations. The acquisition, if consummated, would be the first in CMI’s history. Furthermore, it represented a significant departure from the company’s present business. Randall and Dolan knew that the acquisition could have major implications, both for themselves and for the company they had revitalized over the past several years. Jim Dolan ignored Frank Randall’s intense look and gazed out the eighth-floor window overlooking Philadelphia’s Independence...
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...Foundations and Trends R in Finance Vol. 4, No. 4 (2009) 247–325 c 2010 V. V. Acharya, T. Cooley, M. Richardson and I. Walter DOI: 10.1561/0500000025 Manufacturing Tail Risk: A Perspective on the Financial Crisis of 2007–2009 By Viral V. Acharya, Thomas Cooley, Matthew Richardson and Ingo Walter Contents 1 Introduction 2 How Did We Get There? 2.1 2.2 2.3 The Panic of 1907 and Its Aftermath Bank Competition, Financial Innovation and Risk-Taking in the Last Decades of the 20th Century Risk-Taking Incentives of Financial Institutions 249 253 253 258 264 3 The New Banking Model of Manufacturing Tail Risk 4 Alternative Explanations of the Financial Crisis 5 Conclusion A Appendix: Tail Risk in the Rest of the World References 273 292 311 314 320 Foundations and Trends R in Finance Vol. 4, No. 4 (2009) 247–325 c 2010 V. V. Acharya, T. Cooley, M. Richardson and I. Walter DOI: 10.1561/0500000025 Manufacturing Tail Risk: A Perspective on the Financial Crisis of 2007–2009 Viral V. Acharya1 , Thomas Cooley2 , Matthew Richardson3 and Ingo Walter4 1 2 3 4 Stern USA, Stern USA Stern USA Stern USA School of Business, New York University, New York, NY 10012, vacharya@stern.nyu.edu School of Business, New York University, New York, NY 10012, School of Business, New York University, New York, NY 10012, School of Business, New York University, New York, NY 10012, Abstract We argue that the fundamental cause of the financial crisis of 2007–2009 was that large, complex...
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...Case 1: Capital Mortgage Insurance Corporation Background Capital Mortgage Insurance Corporation (CMI) is a wholly owned subsidiary of Northwest Equipment Corporation (NEC).NEC expects Frank Randall, company president; to build CMI into a larger more diversified financial service company. To do this Randall wants to acquire Corporate Transfer Services (CTS) a small relocation services company, as part of a plan for diversification. Informal discussions took place with the principal stockholders of CTS four months ago. Currently, formal negotiation strategy plans are in the works and a purchase offer is in the development stage. If successful, the acquisition of CTS will be a first for CMI and will help Randall realize his goals for CMI diversification. Analysis CMI’s main interest is to expand their financial services and build a strong company that can hold their own against industry leader, Merrill Lynch. CMI must acquire CTS at a reasonable price to achieve this goal. They also need to retain key employees to manage CTS’s current business interests, and to foster a good relationship with CTS founder, Elliot Burr. This will allow them to make an entry into his Metro Net “old boy” network. Benefits for CMI include - a huge jump start into the corporate relocation business, immediate licensing and other legal documentation in 38 states, influential entry into the Metro Net network which would lower operation of CTS, an experienced operations manager in Tom Winder, and finally...
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...The Global Roots of the Current Financial Crisis and its Implications for Regulation Anil Kashyap (University of Chicago) Raghuram Rajan (University of Chicago) Jeremy Stein (Harvard University) Where did the current financial crisis come from? Who or what is to blame? How will it be resolved? How do we undertake reforms for the future? These are the questions this paper will seek to answer. The analysis will have three parts. The first is a rough and ready sketch of the global roots of this crisis. Second, we will focus in a more detailed way on why it hit the financial sector, especially banks. Finally, we will end with some suggestions for future regulation, especially capital regulation. I. A Rough Sketch. It is always useful to start with the macroeconomic environment. In a sense, this is a crisis borne out of previous crises. An important difference between the recent period of sustained growth and previous periods is the low level of long term real interest rates over the last 5 years, certainly relative to the last two decades. Long rates fell following the collapse in investment in both emerging markets and developed countries after the crises in 1998 and the ICT bubble in 2001. Emerging market governments became more circumspect and increased budgetary surpluses, even while cutting back on public investment. For instance, in Philippines, investment fell from 24% of GDP in 1996 to 17% in 2006, while its savings rose from 14% to 20%. From borrowing 10% of its...
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...December 1, 2012 HRM 594-60124 Negotiation Skills Keller Graduate School of Management Cast Study 1: Capital Mortgage Insurance Corporation In any good negotiation, it is important that the Capital Mortgage Insurance Corporation (CMIC) and Corporate Transfer Services (CTS) understand the issue and must come into the negotiation with a clear idea of what the conflict is and what they would like to gain from it. Both companies should present their side of the case. The dilemma is the president of Capital Mortgage Insurance Corporation, Frank Randall and his senior vice president and treasurer Jim Dolan are planning a strategy in order to compete and successfully receive the acquisition of Corporate Transfer Services. In order for Capital Mortgage Insurance Corp to accomplish this, they must understand the interest and position of Corporate Transfer Services. Once this is accomplished, Randall and Dolan must come into the negotiation with a clear idea of what the conflict is and what they would like to gain from the negotiation. If the Corporate Transfer Services is unwilling to agree or reach an impasse, then CMIC should ask questions such as, what are you concerns and ultimately, what would you like to see happen with this transition? CMIC must be willing to actively listen to the concerns of CTS and be willing to explore other solutions in order to fulfill the agreement. The bulk of the negotiation process is a continuous back and forth of ideas, options, and even arguments...
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...2.1 Key factors in case study 2.1.1 Saving factors in the case As we know, Alexander is a forty-eight year-old CEO of Graphic Design Ltd. He draws a salary of £420,000 per annum. He and his wife Janet have a 14-year-old boy, 10-year-old girl and 3-year-old girl, named Adam, Sheila and Carina respectively. Janet is already 44 and works as her husband`s personal assistant with salary of £55,000 per annum. So the annual household income of his family is £475,000 totally. Adam and Sheila studied in a local private school. The couple will have to pay £3,000 per child per annum in school fee, what was more when Carina arrived her school age, and at that time she will probably be sent into the same school. 2.1.2 Mortgage factors in the case The Flynn’s live in a bungalow which is conservatively evaluated £1.25m in firm economic condition. They have £450,000 mortgage to pay in 14 years. They decided to build an extension which cost £300,000. They have taken out the over 20 year’s mortgage on an endowment basis. A substantial shortfall leads to policy operational problems. 2.1.3 Protection factors in the case As a Company Director and Chief Executive of a software company, Alexander is already 48 and close to his middle-age. Great work pressure may easily cause health problems. Janet is 44 and works as Alexander's personal assist. So this couple needs to protect health to deal with the pressure and workload. Their three children also need to protect health to prevent accident...
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...not line up sufficient liquidity to withstand this crisis in 2008. Two subjects was the problem. The first was that the securities that Bear Stearns had its capital tied up in were risky assets. In such a crisis, the liquidity will disappear for assets. If they took measures before and kept their assets at a better credit quality, this problem wouldn’t occur as harsh as it did. And the second problem occurred when Bear sterns was extremely leveraged comparing to other investment banks. When a company is highly leveraged it’s because they are very confident about their investments long term and in the short term, but that was not the case for bear sterns as we will get into. Their liquidity issues were caused by the...
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