session7 - Session 7 Financial Innovation Traditional...

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Session 7 Financial Innovation
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2 “Traditional” Banking Originate and hold money market instruments junk bonds commercial paper market Pressure on profits Growth of shadow banking
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0.6 0.8 1.0 1.2 1.4 1.6 1.8 84 86 88 90 92 94 96 98 00 02 04 06 08 10 3 Rise of Securities Loans/debt securities ratio US non-financial business sector Source: Federal Reserve, Flow of Funds Accounts, table L101
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4 Financial Innovation Key drivers profit maximisation competition regulatory burden volatility technological change Financial engineering Structured products
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5 Reinventing Banking New business lines Active risk management Balance sheet squeeze Some key instruments interest rate swaps credit risk swaps securitisation
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6 US Interest Rate Volatility Source: St Louis Federal Reserve Bank, online FRED database 0 2 4 6 8 10 12 96 98 00 02 04 06 08 10 % Corporate Baa bond yield US Treasury 10yr bond yield 3mth CD rate
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7 Global ET Derivatives Exchange-traded derivatives notional amounts outstanding Source: BIS quarterly report, Dec 2009 Interest rate Currency Equity index Exchange-Traded Futures ($21trn in 2009) Exchange-Traded Options ($48trn in 2009)
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8 Global OTC Derivatives OTC derivatives notional amounts outstanding Source: BIS quarterly report, Dec 2009 0 200 400 600 800 98 00 02 04 06 08 10 US$trn Total contracts o/w interest rate swaps o/w credit default swaps
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9 arrangement fee income small but low risk As intermediary reduce funding costs widen funding sources hedge existing exposures speculate As principal
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