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Requires understanding understanding investments

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Unformatted text preview: ecuritization crisis crisis Continued development of derivatives and Continued exotics, more regulation for “over the counter” derivatives counter” Strong fundamental foundation of Strong understanding is critical understanding Understanding corporate finance requires Understanding understanding investments understanding 1-45 1.7 The Financial Crisis of 2008 • Changes in Housing Finance • Low interest rates and a stable economy created housing market boom, driving investors to find higher-yield investments • 1970s: Fannie Mae and Freddie Mac bundle mortgage loans into tradable pools (securitization) • Subprime loans: Loans above 80% of home value, no underwriting criteria, higher default risk 1-46 1.7 The Financial Crisis of 2008 • Mortgage Derivatives • CDOs: Consolidated default risk of loans onto one class of investor, divided payment into tranches • Ratings agencies paid by issuers; pressured to give high ratings 1-47 1.7 The Financial Crisis of 2008 • Credit Default Swaps • Insurance contract against the default of borrowers • Issuers ramped up risk to unsupportable levels • AIG sold $400 billion in CDS contracts 1-48 1.7 The Financial Crisis of 2008 • Systemic Risk • Risk of breakdown in financial system — spillover effects from one market into others • Banks highly leveraged; assets less liquid • Formal exchange trading replaced by over- the-counter markets — no margin for insolvency protection 1-...
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