Q1)Question:

Essay question: 20 marks.

Reflect on our class discussion and documentary regarding the Global Financial Crisis (GFC).
Explain the sequence of events that lead to the GFC. If you could remove one events in this
sequence, do you believe the Global Financial Crisis would have still happened?
Now, think about your country of origin (i.e,C_h_i_n_a_,_ _I_n_d_i_a_,_
_B_a_n_g_l_a_d_e_s_h_,_ _e_t_c_…)_._ _D_o_ _y_ou think this same sequence could
cause a crisis there? Would removing the same event have the same expected impact as in
the case of the US economy?

Answer:
The Global financial crisis started way before the effects were observed by
the world. In early 2000, the interest rates were as low as 1 % making
housing loans affordable for many Borrowers. People bought housing as a
part of investments. Many of the home owners couldn’t have afforded if
there had been a better regulation to verify the borrower’s financial
credentials. These are called to be “liar Loans”. Many companies such as
Goldman Sacs, Morgan Stanley, Lehman Brothers were earning from the
mortgages in wall street. However, Subprime mortgages (mortgages
provided to the buyers when they do not meet the requirement for Prime
mortgages) As the demand increased, the value and the interest rate started
increasing. By 2005, the interest rate was as high up to 5.25 making it tough
for the borrowers to repay making them default. This was the root cause of
the GFC.
This was thought to be an issue for just the borrowers. However, Bear
Stearns owned a piece of housing business and they took risks to extreme
levels risks as the individuals started to default and repayment reduced,
they started to face liquidity issues. “Throughout the global financial crisis
that began in mid-2007, many banks struggled to maintain adequate liquidity.
The crisis illustrated how quickly and severely liquidity can crystallize and
certain sources of funding can evaporate, compounding concern related to the
valuation of assets and capital adequacy”.1Apart from that many investors
withdrew from bear Stearns thinking it was up to no good.
As per the U.S. Glass-Steagall Act of 1933, the commercial banks and the
financial services were separated leaving commercial banks with very few
services that it could provide its customer. This made up for the lack of
regulations in and govt securities in the sector. As they were not been
monitored as suppose to the investment or foreign banks. As there were no
transparency in the system, the government was unaware of the issues that
they had to face in the future.
As the system was so interconnected, the aftermath of these organization
hit the wall street. However, the Bear Stearns was helped by the govt, other
organizations such as Fannie Mae and Freddie Mac (the backbone of the
mortgage market) was led to bankruptcy. They believed that they had
government’s implicit guarantee. Next were the Lehman brother and the
Merlin Lynch. Merlin lynch was safeguarded by bank of America however,
Lehman brothers took the hard hit. And this wasn’t all over the course of
Crisis other companies such as AIG also faced the same until the
government came in to bail out.
This is an example of how the market is interconnected. Even a single
occurrence with the causes might lead to same situation that the world had
gone through. I believe that causes such as Liberalisation of Banking sector,
Interconnected markets, Subprime loans moving on a verge to default and
liquidity can provide with a similar output as we went through the in 2008
and 2009.Irrespective of the sequence of the events, if such causes persist
this might have led to GFC.
Now talking about the country of origin, I believe that the causes might be
differ but if such a situation persist, a financial crisis is bound to occur. India
have had a regulated Banking sector since the nationalisation of banking
from 1969.Hence the regulations or transparency in the banking sector
might not be the cause of the global crisis. However, there are other
parameter that could lead to a similar situation such as frequent changes in
political parties, thus making changes in the rules, corruption. The examples
such as crisis in 1991 which happened as they there less foreign reserves 2
and nationalisation of banks in 1969 had led to financial crisis in India. IN IN
Being one of the largest growing economies and the markets being
interconnected it would have a similar aftermath as the 2008 crisis. Infact as
the markets were so interconnected, the 2008 GFC had causes in the Indian
economy.

Citations

1)Eun, Cheol S, et al. International Financial Management. New York, Mcgraw-Hill

Education, 2020.

2) https://www.imf.org/external/pubs/ft/staffp/2002/03/pdf/cerra.pdf
For reference video doc: Eun, Cheol S, et al. International Financial Management. New

York, Mcgraw-Hill Education, 2020.

Q2) Consider the following information:

You have $15,000 USD today and are willing to invest over a 3-year period. You have two choices:
i) Convert the money to Japanese Yen at the current FOREX spot rate. Then invest the Yen in a series
of three 1-year interest-bearing time deposits. For example, after the first year elapses and its
interest accrues, you then invest the total proceeds (principle + interest) again for another year, and
so forth. OR,
ii) Invest the money in a 3-year USD time-deposit account.

In 1-2 paragraphs with supporting calculations or algebra, explain under what conditions could an
arbitrage opportunity occur? How likely would this be?

Answer: