Dr. P.V. Viswanath

pviswanath@pace.edu

Review Questions to Study and Prepare

Note that you are not responsible for questions marked with an asterisk

Risk Sharing and Risk Management

1. If there are two individuals with the same willingness to take risk, could there be an asset whose risk one individual would be willing to shoulder, but not the other? Explain with an example.
2. Why would a homeowner borrow in a currency not his own, to finance his home purchase?
   1. Does this increase his risk or decrease it?
   2. If you think his risk is increased, how can he protect himself against this additional risk?
3. *What's a floater? What's an inverse floater? Give examples.
4. *How sensitive are floaters and inverse floaters to changes in interest rates? How is this useful to investors?
5. What is securitization?
6. Why might a bank want to securitize its loans?
7. What are mortgage-backed securities (MBS)?
8. Why are MBSs riskier than ordinary bonds?
9. What are Principal Only and Interest Only securities? What is their purpose?
10. What are TIPS? What is the purpose?
11. What are ETFs? What are their advantages?
12. What is the advantage of an actively-managed ETF?
13. What is the problem with making an actively-managed ETF work? How can the problem be solved?
14. *What are captive insurance companies? What are their advantages?
15. What are collateralized loan obligations?
16. *What are credit derivatives?
17. *What are the uses of credit derivatives?
18. What are weather bonds? How do the weather bonds issued by Koch industries work?
19. What are catastrophe bonds? How do they work?
20. What are Cateputs? What is their purpose?

Information Asymmetry and Agency Costs

1. What is information asymmetry? Why can it be a problem?
2. What are agency costs?
3. What is moral hazard?
4. How does moral hazard apply to insurance?
5. What is the difference between moral hazard and adverse selection?
6. How do high cash-down mortgages affect moral hazard?
7. Why do stock prices drop, when a new equity issue is announced?
8. What is putable stock and how does it solve the adverse selection problem?
9. *What was the innovation of the Bear Stearns MBS deal?
10. *How does decoupling credit and interest-rate risk solve the adverse selection problem when banks desire to sell off their mortgages?
11. What is the advantage of project financing?
12. What are tracking stocks and how do they resolve the adverse selection problem?
13. Why do firms with debt tend to take excessive risk?
14. How does convertible debt solve the problem of excessive risk-taking?
15. Why was Hudson Bancorp willing to give customers a discount to buy its stock?
16. *What is debt overhang?
17. *How does senior debt resolve the debt overhang problem?
18. *How does staged financing resolve the debt overhang problem?

Securitization

1. What is securitization?
2. How is securitization achieved?
3. What are the advantages of securitizing home mortgages?
4. *What is the purpose of credit enhancements?
5. *What are some external credit enhancements?
6. *What are some internal credit enhancements?
7. *What are sequential pay tranches?
8. *What are floating rate tranches?
9. *What are targeted amortization class bonds?
10. *What are Very Accurately Determined Maturity Bonds?
11. What are Asset Backed Securities?
12. *How can insurance risks be securitized?
13. What are Rock-n-Roll bonds?
14. How would you value Rock-n-Roll bonds?
15. What are Tobacco bonds?
16. What are special facility bonds? What is their function?

Financial Innovation and the Macroeconomy

1. How do financial innovations improve consumer welfare?
2. What are some of the financial innovations that improve the efficiency of payments in the economy?
3. How does the financial system decentralize the collection of information?
4. Here are different financial system functions:
   Payments system for the exchange of goods.
   Mechanism for the pooling of funds for large-scale indivisible enterprises.
   Transfer of economic resources through time and across geographic regions and industries.
   Management of uncertainty and control risk.
   Provision of price information to coordinate decentralized decision-making.
   Managing “agency” costs.
   For the following financial innovations, explain which functions are affected:
   1. Asset Backed Securities
   2. Credit Cards
   3. Hedge Funds
   4. Currency Swaps
   5. *Range Floaters
   6. Futures markets
   7. Convertible bonds
5. *What are the different roles that government has in the functioning of the financial system? What is the relevance of these roles for financial innovation?
6. *Explain the process of new security creation through underwriting
7. *Explain how new securities can be synthesized.