||Investors' Reflection on Structure Notes After Subprime Mortgage Crisis
||Institute of International Management (IIMBA--Master)(on the job class)
The Federal Open Market Committee decided to lower its target for the federal funds rate 50 basis points to 4-3/4 percent on September 18, 2007. They mentioned the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth across the board. The action was intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time. Although this statement imperturbably described the reason why the rate was cut to 4.75% from 5.25%, the financial markets have experienced a terrible period all over the world. This is due to the subprime mortgage crisis, which resulted from delinquencies and foreclosures from borrowers due to an increase of interest rates and the highly profitable derivatives, underlying subprime mortgage and related subprime lending in America.
The biggest subprime mortgage lender New Century Financial Corporation almost filed for bankruptcy after the housing bubble. In the late July of 2007, the capital value of Bear Stern’s two hedge funds was close to nothing due to subprime mortgage crisis, the Dow Jones Industry Average then proceeded to drop over seven hundred points or 5% in one week from 7/23 to 7/27, the biggest single-week decline since 2002.
Similar incidents were taking place in Europe; three mutual funds issued by BNP Paribas Bank stopped redeeming, this created fear among global investors. The European Central Bank, Federal Bank, Bank of Japan and many central banks in the world all injected massive amounts of money to the financial markets to help stabilize the delinquent mortgage market. Derivatives of subprime mortgage, such as Collateralized Debt Obligation (CDO), Asset Backed Securities (ABS), and Mortgage Backed Securities (MBS), were widely invested in by financial institutions, insurance companies, investment banks, securities companies, hedge funds and mutual funds. These were the main buyers, these products were then segmented, and the derivatives and sold in small pieces to the endmost investors.
The structure notes linked to derivatives of subprime mortgage were also sold in Taiwanese banks and resulted in a significant loss of investor’s wealth due to information asymmetry. Most of the structure notes underlying subprime mortgage were short term, with high interest and good rating attached. Investors in Taiwan were convinced these structure notes were core portfolios and invested a lot of money in them. These investments were due to recommendations from personal bankers or financial consultants employed by Taiwanese banks, these employees didn’t fully understand the inside risks and content.
The research’s objective are exploring the selling procedure of structure notes in financial institutions, avoiding information asymmetry between financial institutions and investors and making meaningful suggestions to wealth management in Taiwan.
Through interviewing market participants and supervisors, the research specified the sources to know the subprime crisis, cause of the subprime crisis, reasons and motivation to invest structure notes, risk disclosure and potential profit in selling of structure notes, condition of controversy handling of structure notes, characteristic of wealth management in Taiwan and perception of structure notes after the subprime crisis. The research also synthesized the responses from in-depth interview and concluded valuable suggestions to both financial institutions and investors.
TABLE OF CONTENTS IV
LIST OF TABLES VII
LIST OF FIGURES VIII
CHAPTER ONE INTRODUCTION 1
1.1 Research Background 1
1.2 Research Motivation and Purpose 2
1.3 Research Structure and Procedure 3
CHAPTER TWO LITERATURE REVIEW 5
2.1 Definition of Subprime Mortgage 5
2.2 The Market and Background of Subprime Mortgage Crisis 6
2.3 The Types of Derivatives Underlying Subprime Mortgage 8
2.3.1 MBS and RMBS 8
2.3.2 ABS 9
2.3.3 CDO 9
2.4 Inside Risk and Trip of Derivatives Underlying Subprime Mortgage 12
CHAPTER THREE RESEARCH DESIGN AND METHODOLOGY 14
3.1 Case Study 14
3.2 In-Depth Interview 15
3.2.1 Questionnaire Design and Development of In-Depth Interview 16
CHAPTER FOUR RESEARCH FINDINGS AND RESULTS 20
4.1 Case Study 20
4.1.1 Framework of the Structure Note 20
4.1.2 Scenario of the Structure Note’s Selling 21
4.1.3 Ending of the Structure Note 22
4.2 In-Depth Interview of Market Participant 31
4.2.1 Design and Operation of In-Depth Interview 31
4.2.2 In-Depth Interview of Market Participant 31
4.2.3 Pareto Analysis 33
4.2.4 The Results of Sources to Know the Subprime Crisis 35
4.2.5 The Results of Cause of the Subprime Crisis 36
4.2.6 The Results of Reasons and Motivation to Invest Structure Notes 37
4.2.7 The Results of Risk Disclosure and Potential Profit in Selling of Structure Notes 38
4.2.8 The Results of Condition of Controversy Handling of Structure Notes 39
4.2.9 The Results of Characteristic of Wealth Management in Taiwan 40
4.2.10 The Results of Perception of Structure Notes after the Subprime Crisis 42
4.2.11 Summary of Key Factor………………………………………………………….43
4.3 In-Depth Interview of Market Supervisor 43
4.3.1 In-Depth Interview with Commissioner Shyan-Yuan Lee 44
4.3.2 In-Depth Interview with OfficerA of Banking Bureau 45
4.3.3 In-Depth Interview with OfficerB of Banking Bureau 46
4.3.4 Perspective of Market Supervisor after the Subprime Crisis 47
CHAPTER FIVE CONCLUSION AND SUGGESTIONS………………………………….48
5.1 Research Conclusion 48
5.2 Research Suggestion and Discussion 50
APPENDIX SURVEY QUESTIONNAIRE 57
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