Financial Disintermediation

The world’s financial system was almost brought down in 2008 by the collapse of Lehman Brothers that was a major international investment bank at that time. The government sponsored these banks’ bailouts that were funded by tax money in order to restore the industry. Before the crisis, banks were lending irresponsible mortgages to subprime borrowers who had poor credit histories. These mortgages were purchased by banks and packaged into low-risk securities known as collateralized debt obligations (CDOs). CDOs were divided into tranches by its default risk. The ratings of those risks were determined by rating agencies such as Moody’s and Standard & Poor’s. However, those agencies were paid by banks and created an environment in which agencies were being generous to ratings since banks were their major clients.

There was a great boom in consumer goods. Ordinary people were encouraged through advertising and could now afford to buy goods like cars, refrigerators, radios, and among other luxuries that became necessities. These new inventions made home life easier for women and more enjoyable for men. Also, there was this “mass production” method to produce many consumer goods. Assembly lines like, Henry Ford’s factory. Production costs fell quickly, wages rose slowly, and prices remained constant. For example, in 1908 the average cost of the car was $850, but by 1925 that cost had dropped to $290. Many people invested their money into businesses. Some, bought stocks sold on the stock market, when companies did well, so did

| led to a flurry of mergers that left the country with just five major banks.

Companies lost so much money that some were forced to lay off workers and even shut down. Over spending and installment buying along with the stock market crash led to many people not only losing their savings but also their

Then, in the 1990s, bonds were created consisting of subprime mortgages, which were higher risk mortgages with high interest rates, made to borrowers with lower credit levels. Essentially, banks were handing out mortgages like candy to consumers who were never going to be able to make the payments, but Wall Street kept buying and packaging the mortgages into bonds. Since these bonds were inherently riskier, one wonders why investors were still willing to buy. Investors, who look at ratings by agencies such as Moodys and Standard & Poors, had no reason to believe these bonds were risky investments. The agencies, whom were being paid by Wall Street, were assigning high ratings to these risky bonds.

Furthermore, those banks who invested in collateral debt obligations, a lot of whom before 2007 (particularly investment banks) sold off senior CDOs but kept junior ones for profit (8). However, the values of these CDOS plummeted and as a result banks with large amount of junior CDOS were in a bad position therefore many investment banks were in

After the financial crisis, many new rating agencies announced their entry into the credit rating business. Many of them were prominent to the public and owned a great quantity of resource. The entering of new firms made the credit rating industry competitive and thus posed a threat on KBRA.

In the early-2000s, Moody’s, one of the leading credit rating agencies in the world, evaluated thousands of bonds backed by so-called “subprime” residential mortgages—home loans made to those with both low incomes and poor credit scores. When housing prices began to fall in 2006, the value of these bonds disintegrated, and Moody’s was compelled to downgrade them significantly. In late 2008, several commercial banks, investment banks, and mortgage lenders that had been

Bank Failures (Over 9,000 banks in the US and over 100,000 around the world failed as deposits were uninsured and people lost their savings. The surviving banks unsure of the economic situation and concerned for their own survival refused to

In addition, WorldCom was not the only company issuing a large supply of bonds at that time. In fact, there were many issues set to hit the market around the same time. The sudden influx of corporate debt into the market would apply pressure on the price of the bonds while granting investors a wide range of opportunity and control. In addition, the economic turmoil in Asia at the time had caused a great deal of uncertainty about the future of the fixed-income market and the overall economy, thus pushing investors towards default-free treasury securities and away from corporate debt.

It provides an evaluation of the bond issuer’s financial strength and ability to pay back the bond’s principle and interest. The bond rating also provides investors with some sense of security when investing in a particular firm. A higher bond rating implies a lower likelihood for the firm to default. Investors would feel more secured investing in such a bond, thus demanding a relatively lower rate of return. As such, high rated bonds enable the issuer to enjoy a lower cost of borrowing. A lower bond rating, on the other hand, serves as a negative signal to investors on the firm’s ability to repay debt obligations.

The third reason given was the bad banking structure which was in place in the 20's and into the 30's. Banks at this time were run individually, thus, when a bank failed or went belly up because of aggregate deposits, it started a domino effect. In 1929 alone, 346 banks closed their doors, leaving people out in the cold, with no money, money which they had trusted in the hands of these banks. This of course left the people with a bad taste in their mouths, and caused them to stop putting money in banks, relying instead on the bottom side of their mattresses. The bad running of banks ties into corruption also. The men who ran banks, men like Charles E. Mitchell, were more interested in keeping the stock market boom going rather then the health of the banks which they ran. These men kept interest rates low and gave bad loans to people who mostly had no hope of ever paying back.

In the first part of our report, we investigate if a 35 basis points yield spread represents mispricing of two bonds, both with the same maturity but one with a coupon rate of 10.625% and the other 4.25%. Our investigation also determines if the yield spread represents an arbitrage opportunity. In our investigation, we calculate the theoretical yield spread between the two bonds and compare the figure with the observed yield spread. It is cited in the case that the observed yield spread could be due to different liquidity premium for each bond or simply due to different durations. Through our calculations, we discover

The book starts by talking about the “bond” and how it is used to make interested payments on borrowed money and then gets paid back in the long-term. In the late 1980’s Wall Street had released that is could create products like credit cared, and home mortgages which were very similar in comparison to bonds themselves. The introduction of mortgage bonds allowed the beginning of home mortgages that is a huge part of the financial crisis of 2008. Within the 1990’s mortgage bonds were created that were a much higher risk; these mortgages are called “subprime.” Due to this addition to the market the risks people were taking on became something that they would not realize. Their actions would soon create the housing bubble that occurred and created this financial crisis years and years later.

A bond is debt to whoever sells the bond to an inventor. If you buy an IBM bond, you are loaning money ($1000) to IBM instead of a bank loaning money to them. Just like a bank, you are going to charge IBM interest on your money, as well as a return of principle when the loan is due (ten years later). The company does not go to the bank to borrow the money, because the bank will rate the company as a high risk company. Hence, banks are really tight with their money. High yields bond investment relies on an credit analysis in that it concentrates on issuer fundamentals, and a "bottom-up" process. It focuses more on "downside risk default and the unique characteristics of the issuer. In a portfolio of high yield bonds,