Package 3 Flashcards

Question

Deciphering the Liquidity and Credit Crunch | margin spiral.

Answer 1

Prices of assets decline -‐> margins rise -‐> investors sell even more to reduce leverage ratio -‐> increase margins further Margins increase after large price drops because: (i) volatility increases, (ii) asymmetric information frictions emerge (financiers become more careful about accepting as collateral)

Answer 2

growth of semiconductor industry which had profound impact on the financial system.

Answer 3

“whatever can go wrong will go wrong” and it corollary “whatever can go wrong will go wrong faster and bigger when computers are involved”

Answer 4

the use of mathematical models, computers and telecommunication networks to automate the buying and selling of financial securities.

Answer 5

A more systematic and adaptive approach to regulating this system is needed, one that fosters the technological advances of the industry while protecting these who are not as technologically advanced.”

Answer 6

o Lower costs (bid ask-spread) o Reducing human error (ex: broker doesn’t buy the needed stock) o Increasing productivity

Answer 7

o The regulatory framework doesn’t adjust so fast to technological innovation.

Answer 8

1) Financial markets are becoming more complex 2) Developments in the financial technology/financial modeling. 3) Breakthroughs in computer technology.

Answer 9

1) Quantitative models 2) Emergence and proliferation of index funds 3) Arbitrage trading activities 4) Push for lower costs of intermediation and execution a. One doesn’t have to go to the market to sell all his stocks/bonds/CDOs etc. 5) Proliferation of high-frequency trading (40-60% of all trading activities)

Answer 10

Collection of securities by some set of easily observable attributes, construct a portfolio weighted by their market capitalization.

Answer 11

liquidity provisions and price discovery

Answer 12

A form of automated trading that consumes extremely many trades per day/ second. It is an innovation in financial inter mediation that does not fit neatly into a standard liquidity-provision framework.

Answer 13

placing an order to buy or sell a security and then cancelling it shortly thereafter.

Answer 14

placing a sequence of limited orders at successively increasing or decreasing prices to give the appearance of change in demand or artificially increase or decrease the price.

Answer 15

1) Do nothing 2) Banning high-frequency trading 3) Change the definition and requirements of a market maker 4) Force all trades to occur at distinct time intervals 5) Tobin tax (small transaction tax on all financial transactions)

Answer 16

+ Allow for intermediaries to find their own ways to optimize costs, leading to an even greater supply of immediacy and efficient trading - Unlikely to address investor’s concerns about fair and orderly markets.

Answer 17

+ More fair and orderly markets in the short-run | - Reduce market liquidity, efficiency, capital formation

Answer 18

+ Fair and orderly market (No withdrawal when their services are needed) - Increase the cost of intermediaries of being present, greater legal costs

Answer 19

+ Higher supply of immediacy | - Investors seemed to prove having preference for continuous systems

Answer 20

+ Increase government budget | - Decrease liquidity, transactions will migrate to other countries

Answer 21

1) System engineered 2) Safeguards-Heavy 3) Transparency-Rich 4) Platform-Neutral

Answer 22

Financial regulations should approach automated markets as complex systems composed of multiple software, not only from human side perspective.

Answer 23

Regulation should encourage safeguards at multiple levels of the system to check the fairness and the order in all transactions.

Answer 24

Financial regulation should aim to make the financial operations more transparent and accessible.

Answer 25

Financial regulation should be designed to encourage innovation in technology and finance and should be neutral how computer systems in this financial system work.

Answer 26

August 2007: Arbitrage Gone Wild - Record loss of hdge fund May 6, 2010: The Perfect Financial Storm - Order imbalance; At some point of time investors saw the highest volatility (e.g. Apple stock) orders were really enhanced March and May 2012: Pricing Initial Public Offerings in the Digital Age - i. Facebook IPO delayed by half an hour. Took more time to calculate initial price. And when it was recalculating new offers came in place and many were cancelled.; BATS Global Market, cancelled IPO, due to “computer” glitch August 2012: Trading Errors at the Speed of Light - i. Knight Capital lost 400m USD and went bankrupt. Algorithm dint manage to pick errors and had to sell hundreds of assets in open markets. In half an hour, the whole capital was wiped out. (150 stocks decreased in their price) September 2012: High-Frequency Manipulation - Put the orders, so that price would decrease

Answer 27

* Portfolio theory * CAPM * BS option pricing * Optimization models

Answer 28

* The financial system becoming more complex over time * Breakthroughs in the quantitative modeling of financial market * Breakthroughs in computer technologies

Answer 29

is highly persistent systems or style of social control on economic life.

Answer 30

Authors argue that common law stands for the strategy of social control that seeks to support private market outcomes, whereas civil law seeks to replace such outcomes with state-desired allocations.

Answer 31

English colonies and English speaking countries: United States, Australia, Canada.

Answer 32

* Role of judges: large (independent judges with longer tenure); * Jurisprudence matters (appellant judges establish precedents); * Judging based on cases; can make decisions that later will be taken as precedent. Law interpretations. * Stands for social control that seeks to support private markets outcomes; * Dispute resolving.

Answer 33

French law (original Civil law), German law (accomodates greater judicial law making) and Scandinavian Law

Answer 34

* Role of judges: small (statutes and comprehensive codes based on Roman Law); * Seeks state desired allocations; * Policy implementing.

Answer 35

``` • Civil law  Lower capital market development Lower # of firms per capita Higher ownership concentration Lower private credit to GDP • Common law - Improved financial development - Better access to finance - Higher ownership dispersion ```

Answer 36

1. Historically England and continental Europe have different styles of social control of economic life; 2. These laws were involuntary transplanted via colonization to the rest of the world; 3. Although many legal and regulatory changes happened; these styles persist till now.

Answer 37

Legal rules & regulations differ across countries and these differences can be measured; diff in rules & reg are accounted by legal origins; the measured difference matters for economic and social outcomes. The authors don’t know which regulation will be in the future (if they don’t converge). But they think that common law approach to social control over economic life is better (when markets work well it is better to support them). But if bad times => civil law is better.

Answer 38

``` COMMON LAW  Less corruption  Better functioning labor markets  Smaller gray economies CIVIL LAW  Corruption  Unofficial employment  Lower labor participation rate ```

Answer 39

``` COMMON LAW  Secure property rights  Better contract enforcement CIVIL LAW  Lower security of property rights  Weaker contract enforcement ```

Answer 40

Some countries have no choice. Because they are small, or because they are close to other countries, they are likely to have more trade. Therefore, these countries are likely open for reasons that are not political. If important parts of the world are open, then natural leakages across borders (the gray trade, smuggling, under-invoicing, over-invoicing, etc.) are likely to be high and make it hard for a country to remain closed. The economic importance of other countries that are open can be thought of as largely exogenous to a country’s domestic politics.

Answer 41

First, in examining the link between trade openness and financial development, we instrument trade openness with a measure of natural openness (largely based on a country’s distance from its trading partners). We thus focus on the exogenous component of a country’s trade. Because distance matters less for capital, we do not have a similar instrument for cross-border capital flows. But precisely because capital is more mobile, the strategic complementarities in cross-border capital flows are likely to be stronger. So we can use world-wide cross-border capital flows over time as an exogenous measure of whether countries are more open to capital flows. International capital mobility is high both in the beginning and towards the end of the twentieth century for most countries. Thus, we test in the cross-section of countries if financial development is positively correlated with the exogenous component of a country’s openness to trade (correcting for the demand for finance), both in the beginning of the century and towards the end of the century, and it is.

Answer 42

The right measure would capture the ease with which any entrepreneur or company with a sound project can obtain finance, and the confidence with which investors anticipate an adequate return. Presumably, also, a developed financial sector can gauge, subdivide, and spread difficult risks, letting them rest where they can best be borne. Finally, it should do all this at low cost.

Answer 43

Banking sector Equity issues Capitalization Number of companies listed

Answer 44

 We use the ratio of deposits (commercial banks plus savings banks) to GDP as a measure of the development of the banking sector.

Answer 45

 The proxy we use is the ratio of equity issues by domestic corporations to gross fixed capital formation (GFCF) during the year.

Answer 46

 A more stable measure of the importance of the equity market is the total stock market capitalization.

Answer 47

 A final indicator of the importance of equity markets is the number of publicly traded domestic companies per million of population. One indicator that is missing from our list is the volume of securities traded.  Unfortunately, the way volume is recorded (even today) is quite controversial.

Answer 48

 respect for property rights,  an accounting and disclosure system that promotes transparency,  a legal system that enforces arm’s length contracts cheaply, and  a regulatory infrastructure that protects consumers, promotes competition, and controls egregious risk-taking.

Answer 49

 A more efficient financial system facilitates entry, and thus leads to lower profits for incumbent firms and financial institutions.

Answer 50

1. For any given level of demand for financing, a country’s domestic financial development should be positively correlated with trade openness at a time when the world is open to cross-border capital flows. 2. The positive correlation between a country’s trade openness and financial development should be weaker when worldwide cross-border capital flows are low.

Answer 51

* The first is to show the reversal in financial markets, a finding inconsistent with pure structural theories of financial market development. * Second, is fact, that trade openness is correlated with financial market development, especially when cross-border capital flows are free. * Third, we argue that findings are consistent with interest group politics being an important factor in financial development across countries. * Lastly, we suggest that a county’s institutions might slow or speed-up interest group activities. This might indicate that institutions matter, though the way they matter might primarily be in tempering interest group activities.

Answer 52

If financial development facilitates economic growth, why do so many countries still have underdeveloped financial sectors?

Answer 53

o Financial systems were highly developed in 1913 o Countries most advanced in 1913 do not necessarily stay advanced - Legal Origins Theory works only after WWII o Indicators of financial development fall then rise between 1913 and 1999

Answer 54

1) Direct-entry restriction (ex: licensing) is very costly (ex: competitors create a substitute for the products whose market is restricts) 2) Active enforcement of restrictions on entry is very public and politically transparent (citizens/customers are unlikely to remain ignorant)

Answer 55

o Governments created barriers to imports to get themselves out of depression (many countries followed this strategy, otherwise government won’t be able to financially support/insure its citizens)=> trade and capital flows decreased. o Or incumbents lobbied their rights.  After 1980 trade flows increased, because with the growing volume of trade, it was too difficult for incumbents to control for potential leakage of capital → competition forced financial modernization, and State intervention ↓

Answer 56

• Respect to property rights • Transparent accounting & disclosure system • Well-developed legal system • Infrastructure that promotes competition, protects consumers and controls risk-taking

Answer 57

• Incumbents are against developed financial system • Developed financial systems increase number of market players, boost competition and wipe out incumbents’ profits • Financial system remains underdeveloped if there are bureaucratic barriers, powerful lobby groups against development • Usually incumbents have big political power (lobby) • The only way to promote financial development – dramatic political change

Answer 58

• Common Law countries have more developed financial markets • In Civil Law countries interest groups have higher influence on politic decisions

Answer 59

• Competitive and inclusive financial system can exist only if the rule of laws is respected and expected to be respected in the future

Package 3 Flashcards

(83 cards)