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1.) What does a negative interest rate mean? Why would a government intentionally have a negative interest rate (potential economic benefits)? If the interest rate was negative why would savers (people or businesses) still put their money in banks or invest in government bonds? If the negative interest rate continued to decrease or lasted for a long period of time what would happen? How would a high interest rate impact our economy (consumer spending, loan availability, etc)?

2.) What is the primary difference between direct and indirect finance? Why are banks or private loans a more common source of external financing than the stock market? Discuss how information asymmetry is involved in this decision. Think about the market for lemons and the car example we discussed in class. What problems do information asymmetry cause in the financial markets?

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Trinidad Tremblay
Trinidad TremblayLv2
28 Sep 2019

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Position A: Financial Institutions' role as specialists in risk measurement and management is reduced.

Position B: Financial Institutions' role as specialists in risk measurement and management is increased.

Required:

Read the “background” below. After reading, select the position you agree with and write a position paragraph supporting either Position A or Position B.

Background: A major event that changed and reshaped the financial services industry was the financial crisis of the late 2000s. As Financial Institutions adjusted to regulatory changes brought about in the 1980s and 1990s, one result was a dramatic increase in systemic risk of the financial system, caused in large part by a shift in the banking model from that of “originate and hold” to “originate to distribute.” In the traditional model, banks take short-term deposits and other sources of funds and use them to fund longer term loans to businesses and consumers. Banks typically hold these loans to maturity, and thus have an incentive to screen and monitor borrower activities even after a loan is made. However, the traditional banking model exposes the institution to potential liquidity, interest rate, and credit risk. In attempts to avoid these risk exposures and generate improved return-risk trade-offs, banks shifted to an underwriting model in which they originated or warehoused loans, and then quickly sold them. Indeed, most large banks organized as financial services holding companies to facilitate these new activities. More recently activities of shadow banks, nonfinancial service firms that perform banking services, have facilitated the change from the originate-and-hold model of commercial banking to the originate-and-distribute banking model. In the shadow banking system, savers place their funds with money market mutuals and similar funds, which invest these funds in the liabilities of other shadow banks. Like the traditional banking system, the shadow banking system intermediates the flow of funds between net savers and borrowers. However, instead of the bank serving as the middleman, it is the non-bank financial service firm, or shadow bank, that intermediates. Further, unlike the traditional banking system where the complete credit intermediation is performed by a single bank, in the shadow banking system, it is performed through a series of steps involving many non-bank financial service firms. These innovations remove risk from the balance sheet of financial institutions and shift risk off the balance sheet and to other parts of the financial system. Thus, the financial institutions, acting as underwriters, are not exposed to the credit, liquidity, and interest rate risks of traditional banking.

In your own words, explain what is meant by business and financial risk. Suppose Firm A has greater business risk than Firm B. Is it true that Firm A also has a higher cost of equity capital? Why or Why not? Explain.

Consider the following model of the saving-investment balance. In this model, the following relationship must remain in balance: S + (M-X) = I + (G-T) where,

S is domestic saving by households and businesses

M is U.S. imports of goods and services

X is U.S. exports of goods and services

I is private domestic investment in capital goods

G is total federal, state and local government spending on goods and services, and

T is the net receipt of tax revenues by federal, state and local governments

The presentation: “Lesson 1: The Savings and Investment Balance” in this week’s lesson can help you understand this identity better.

Clearly, as with any high-level model, there are limitations but let’s try to understand how this model functions mechanically.Consider the model of the saving-investment balance only as an algebraic accounting identity (i.e., do not consider any economic repercussions or additional complications (those can come later)), What does the model predict will happen to gross private domestic investment (I) if:

a) Domestic saving by households was to decrease, everything else remaining the same?

b) U.S. net tax receipts were to increase, everything else remaining the same?

c) There was a sudden increase in exports from the U.S., everything else remaining the same?

d) Pre-tax business profits were to increase, everything else remaining the same?

e) Federal grants to state and local governments were to disappear, everything else remaining the same?

2. Examine the note and bond yields presented below for Treasury and Corporate AAA, AA and A-rate bonds. Why do the yields differ across the securities and within securities, across time? Which premiums or market expectations most appropriately explain those differences? In particular, what accounts for the differences in rates across securities types for the same maturities? And speculate on what factor or factors can best explain why the yields rise as maturities lengthen (within particular types of bonds). Finally, do any securities look out of place and, if so, which and why?

Treasuries

2 year 0.33%

5 year 1.39%

10 year 2.64%

20 year 3.42%

Corporate, AAA

2 year 0.40%

5 year 1.77%

10 year 3.52%

20 year 4.93%

(table continues on next page)

Corporate, AA

2 year 0.63%

5 year 1.91%

10 year 3.50%

20 year 4.43%

Corporate, A

2 year 0.84%

5 year 2.15%

10 year 3.67%

20 year 4.75%

3. Suppose that today the one-year Treasury note yields 0.12% (0.0012 in decimal form), the two-year note yields 0.40% (0.0040), the three-year note yields 0.78% (0.0078), the five-year note yields 1.60% (0.0160), the seven-year note yields 2.22% (0.0222) and the ten-year note yields 2.81% (0.0281). Under the pure expectations theory with no maturity risk:

a) What is the expected yield on a one-year note delivered one year from now?

b) What is the expected yield on a one-year note delivered two years from now?

c) What is the expected yield on a three-year note delivered two years from now?

d) What is the expected yield on a two-year note delivered five years from now?

e) What is the expected yield on a five-year note delivered five years from now?

f) What is the expected yield on a seven-year note delivered three years from now?

Note: This concept is discussed in Chapter 3 of the text and in “Lesson 2: More On Yield Curves and Forward Rate Determination” in this week’s online materials.

4. Assume that interest rate parity holds so that future or forward exchange rates adjust to eliminate investor arbitrage profits. If interest rates in Britain are higher than corresponding interest rates in Japan, would you expect an appreciating pound or a depreciating pound in the futures (forward) market relative to the current spot market rate? In terms of the supply and demand for pounds in the spot and forward currency markets, what is implicitly occurring in each as a result of interest rate parity? Is the pound selling forward at a premium or at a discount relative to the yen? (The presentation “Lesson 3: On Exchange Rates” from this week’s materials can help shed light on this subject. The portion on interest rate parity later in the presentation, so stick with it. It’s also discussed in Chapter 16.)

5. The spot market rate for the euro is 1.4059 Canadian dollars per euro. The 3-month futures (forward) rate on the euro is 1.4147 Canadian dollars per euro. The yield on a 3-month Canadian government security is 1.16 percent (0.0116 decimal), annual percentage rate (APR). The yield on a 3-month euro area security is 0.24 percent (0.0024 decimal), annual percentage rate (APR). Show that interest rate parity (IRP) does not hold by solving for the forward rate that ensures IRP. How would you take advantage of the arbitrage opportunity arising from the actual data (i.e., borrow 1,000,000 euros, convert to Canadian dollars, invest in Canada, sell the proceeds forward and then repay your loan or borrow 1,000,000 Canadian dollars, convert to euros, invest in Europe, sell the proceeds forward and then repay your loan)?

Assignment Scenario:

As a new marketing associate with Barclays Bank, you are tasked with writing a critical essay summarizing what transpired during the investigation conducted by the United States Department of Justice into the abuse of the London Interbank Offered Rate (LIBOR) interest rate regulated by the British Banker’s Administration. This essay, if chosen by your new employer, will be the report presented to the Board of Directors.

Write a 2–3 page, (not including a title and references page), double spaced, critical essay responding to the checklist items. For assistance with your Assignment, please use your textbook and library research resources. The instructions for you to execute this task are as follows:

Directions for completing this Assignment:

1. Read the “Barclays Bank: Banking on Ethics” case study: case study is below..

2. Learn how to write a critical essay: I will make the changes if need be..

3. Use APA format and citation style, provide a title page and references, and do not forget to use in text citations with their accompanying references so as to avoid plagiarism.

4. In your critical essay that includes your thesis, arguments, support, and conclusion, respond to the following:

Checklist:

● Describe the level of ethical development the executives at Barclays demonstrated

when manipulating the LIBOR interest rates.

● Did Barclays Bank neglect social responsibility? What could they have done to be more socially responsible?

● What actions regarding Corporate Social Responsibility (CSR) could Barclays have engaged in after the scandal broke to set things right and ensure that such an event would not happen again?

● Describe what level of morality would have been demonstrated if executives at Barclays asked themselves, “Even though manipulating the LIBOR will increase company profits, is it the right thing to do in the long run?”

● Explain the importance of ethics and social responsibility in marketing as a result of your case study analysis.

Case study

Chapter 3

On February 28, 2012, the United States Department of Justice announced a criminal investigation into abuse of the LIBOR, an important interest rate regulated by the British Bankers’ Administration. Four months later, London-based Barclays Bank was fined more than $440 million by United States and English financial regulatory agencies for knowingly manipulating the LIBOR to its own advantage. The political and economic uproar that followed the exposure of Barclays’ actions led to several resignations (including that of Barclays’ CEO Bob Diamond) and further criminal investigations. Former governor of New York Eliot Spitzer called the incident “the mega-scandal of mega-scandals,” while journalist Robert Scheer christened it “the crime of the century.” The LIBOR, short for “London Interbank Offered Rate,” is the interest rate banks pay when they borrow money from each other. To calculate this rate, up to 20 influential British banks report their own proposed bank-to-bank lending rates. The highest and lowest rates are trimmed off, and the remaining rates are averaged, creating the LIBOR. A low LIBOR often points to financial stability, while a high LIBOR indicates that banks lack confidence in each other’s economic health. What Barclays was fined for was proposing artificially low bank-to-bank rates to make itself appear more stable than it actually was. However, further investigations indicated that Barclays colluded with other banks—and perhaps even the British government—to impact the LIBOR itself. An unnaturally low LIBOR would suggest greater economic stability than actually existed, misleading investors and loan-seekers in a potentially volatile market, and thus creating profit for the banks involved in the collusion. The rate manipulation carried out by Barclays affects not only London banks and business executives, but also small businesses and individuals—perhaps even you yourself. Because it has historically been considered trustworthy and economically accurate, the LIBOR is used all around the world as an interest rate and financial instrument benchmark. Everything from currency values (including the United States dollar) to multimillion-dollar corporate debts to home mortgages to individual student loans depend on the LIBOR. While it may not seem like it, each of these is a product that is marketed and sold. As loans and exchanges of varying types are banks’ primary sources of profit, banks compete to exchange these products within a market. At the consumer level, consider how many car and credit card commercials you have seen advertising a low interest rate. Hundreds of trillions of dollars’ worth of these financial products have been sold based on the LIBOR—a rate that may not in fact accurately reflect the world’s shaky economic standing. Journalists and economic analysts have been quick to reject the ethicality of Barclays’ actions. As information about the LIBOR scandal broke, TIME contributor Christopher Matthews wrote, “[Barclays’ alleged collusion] speaks to the moral compass, or total lack thereof, of the world’s financial professionals...the public and the government no longer trust the industry to set its own standards for acceptable behavior.” In a piece for

The Nation, Robert Scheer said, “The modern-day robber barons pillage with a destructive abandon totally unfettered by law or conscience and on a scale that is almost impossible to comprehend.” Dennis Kelleher, president of nonprofit financial watchdog organization Better Markets, Inc. was perhaps most condemnatory of all: “What we probably need is to wipe out this entire generation of so-called banking leaders who apparently have no ethics or integrity.” While the total sum of the LIBOR scandal’s consequences are yet to be seen, Barclays’ actions may go down in history as a monumental failure in business ethics and corporate social responsibility.

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