StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

Intenational finance - Assignment Example

Cite this document
Summary
Q2. Many experts argue that when the government bails out a private financial institution it creates a problem called ‘moral hazard’, meaning that if the institution knows it will be saved, it actually has an incentive to take on more risk, not less. What do you think?…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER97.7% of users find it useful
Intenational finance
Read Text Preview

Extract of sample "Intenational finance"

Q2. Many experts argue that when the government bails out a private financial it creates a problem called ‘moral hazard’, meaning that if the institution knows it will be saved, it actually has an incentive to take on more risk, not less. What do you think? A moral hazard exists when one party has a responsibility to advance the interests of another, but has an incentive to pursue his or her own interests first (Dowd, 2009), and the pursuit of one compromises the other. Moral hazards are pervasive in business where one party (i.e. management) is tasked to handle the resources of another (i.

e, the investor). In financial undertakings, the existence of moral hazard comes in many forms, such as where management pays itself excessive compensation out of the funds it manages on behalf of its investor, or where it makes decisions to take on risks that the other has to bear. Where interests of management and investor are not aligned, then there is a potential for moral hazard. From its very definition, moral hazards are inevitable; the key is to keep them under reasonable control, which is the major objective of institutional design.

The link between risk-taking and moral hazards runs according to this rationale: if I am faced with the option to take risks that may be potentially rewarding for us both, but you bear the burden of the risk, then I have the incentive to take them. However, if I were to bear the potential loss, then I will act more responsibly and cautiously (Dowd, 2009). The moral hazard lies in taking the risk for which another has to bear the consequence. The recent subprime crisis was replete with instances of moral hazards gone uncontrolled.

One was the creation of mortgages to subprime borrowers who had little or no capacity to repay the loan (Brummer, 2008), and then selling this loan to Fannie Mae (the Federal National Mortgage Association) which then securitizes the risk and sells it out as mortgage backed securities (MBS). The quasi-governmental natureof Fannie Mae led to the general understanding that whatever the risk to Fannie Mae and its twin institution Freddie Mac (Federal Home Loan Mortgage Corporation) would be absorbed by the U.S. Treasury, thereby eliminating any risk to the financial institution (Yoon, 2009).

The perceived ability to pass on default risks through securitization and increased competition among lenders paved the way for financial institutions to resort to “innovative mortgage option” such as interest only and negative amortization. These “allowed buyers to purchase houses for which they could not sustain the mortgage payments in equilibrium,” and caused a deterioration of lending standards (Zingales, 2008). Moral hazards also crippled the validity of assessments by credit rating agencies such as Fitch, Moody’s, and Standard and Poor’s (S&P), which rated the questionable “innovative” securities as investment grade, in return for which they were paid handsome fees by the very financial institutions that issued these securities.

When government bails out a “too large to fail” financial institution, it practically insures this institution against failure. Moral hazard already pervasive in the industry is therefore greatly enhanced, as evidence of this tendency may be deduced from the years leading to the crisis. Therefore, any bailout must be supported by sufficient institutional safeguards, which at present is highly suspect given the weakness of the credit rating agencies. Even now, Congress is faced with an inflated budget deficit which will have to be shouldered by taxes (Parkinson, 2011) – an indication that the American public is carrying the burden of the bailout plan.

Until evidence proves the host of good intentions expressed by financial institutions so far, the allure of short-term profit to the negation of long-term risk will continue to fuel moral hazards in the financial system. References Brummer, A 2008 “Where the credit crash came from”, Management Today. Haymarket Business Publications Ltd, London, May 2008. pp. 34-37 Down, K 2009 “Moral Hazard and the Financial Crisis,” Cato Journal, vol. 29, no. 1, pp. 141-166. Parkinson, J R 2011 “Boehner, House Republicans to Roll Out ‘Growth Agenda’ Thursday,” ABC News, 25 May 2011.

Accessed 28 May 2011 from http://blogs.abcnews.com/thenote/2011/05/boehner-house-republicans-to-roll-out-growth-agenda-thursday.html Yoon, A 2009 “Fannie Mae draws on U.S. support after $14.8 billion.” Reuters. Aug. 6, 2009. Accessed 28 May 2011 from http://www.reuters.com/article/2009/08/07/us-fanniemae-idUSTRE5756ZH20090807 Zingales, L 2008 “Causes and Effects of the Lehman Brothers Bankruptcy,” Testimony Before the Committee on Oversight and Government Reform, U.S. House of Representatives, 6 October 2008.

Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Intenational finance Assignment Example | Topics and Well Written Essays - 500 words”, n.d.)
Retrieved from https://studentshare.org/other/1423731-intenational-finance
(Intenational Finance Assignment Example | Topics and Well Written Essays - 500 Words)
https://studentshare.org/other/1423731-intenational-finance.
“Intenational Finance Assignment Example | Topics and Well Written Essays - 500 Words”, n.d. https://studentshare.org/other/1423731-intenational-finance.
  • Cited: 0 times

CHECK THESE SAMPLES OF Intenational finance

The Currency Exposure Faced by the British Venture Capitalist

Name Subject Date International finance Coursework 2 Question (a) The Currency Exposure Faced by the British Venture Capitalist The currency exposure is a corporation's insecurity with respect to its future operating cash flows.... It can be simply understood as the possible loss that results from a change in the exchange rates....
7 Pages (1750 words) Essay

International Finance

The paper entitled 'International finance' focuses on Sercu who addresses issues such as domestic capital budgeting, dealing with non-equity financing implication, political risks, and exchange rates, issues to do with spreadsheets and cash flows increment.... hellip; With regards to the exchange rates, the book looks at different scenarios that result in disequilibrium in the market situation....
1 Pages (250 words) Literature review

International Finance

Most of the European countries that had taken part in the war were economically shattered after the war.... The economy growth of Europe began to recover in the year 1948, and in the year 1950 onwards, this economic growth developed rapidly.... … This rapid growth was because of the following factors....
10 Pages (2500 words) Essay

Future Rates: a Means of Dealing for the Future

The future contracting involves a deal that is planned to happen in the future (Pilbeam, 2013).... The agricultural products and crops are… The producers enter into future contracting so that they can control risks of unfavorable price fluctuations (Copeland, 2008) whereas, industrialists who are responsible for transforming raw The production cycle will remain running smoothly without experiencing any interruptions....
5 Pages (1250 words) Essay

International Business Finance - IFM Plc

In this section, the reports explore the diverse sources of finance that IFM Plc can utilize in its expansion into Asia and the factors that impact on the sources of finance.... The financial analysis of the company demonstrates that the joint venture necessitates a €2 million investment that can be… The paper utilizes financial data and computes the WACC, as well as the Net Present Value....
12 Pages (3000 words) Essay

Some Issues of International Business Finance

These include the costs of finance which is captured by the rate of discount and the taxation rate.... From the two scenarios, it is probable to synchronize the presents and the execution of a system of control where the nature and contours are considerably similar from each others perspective....
7 Pages (1750 words) Case Study

Finance For International Business

The paper gives detailed information about the financing that is required to commence a business or to undertake a project and slope it up towards profitability.... The financing requirements of a company vary in accordance with the size and type of the company.... hellip; From this research, it is clear that the processing businesses requires a large sum of capital as they are capital intensive whereas, the retail businesses needs less capital....
10 Pages (2500 words) Essay

International Finance

This essay analyzes that the euro was formed because as a single currency for the eurozone since it provides more merits and benefits as compared to when each nation possessed its own currency.... The benefits of the euro to the region's affiliate states can be viewed from two perceptions.... hellip; From this paper, it is clear that the euro helps to eliminate the fluctuation rates and exchange costs, strengthen one market as well as ensure close co-operation among affiliated states for a stable currency and economy....
9 Pages (2250 words) Research Paper
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us