Financial Bubble

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National Chengchi University
Department of Finance
ETP Graduate Investments
Fall 2010

Case Discussion Questions

Instructor: Professor Edward H. Chow 周行一

Case study: financial bubble
Case: Trouble with a bubble (9-808-067)
1. Why did Irving Fisher believe that stock prices had reached a permanently high plateau? 2. Why did the stock market crash in 1929?
3. Why did influential individuals like Fisher, Keynes and Rockefeller believe that the downturn would only be temporary?

Case study: investment banking business and global financial crisis Case: Investment banking in 2008 (A): Rise and fall of the Bear (KEL378)

1. What role did Bear’s culture play in its positioning vis-à-vis its competitors, and what role might that culture have played in its demise? 2. 2. How did Bear’s potential collapse differ from that of LTCM in the eyes of the Federal Reserve? 3. What would Bear have done differently to avoid its fate?

a. - In the early 2000s?
b. - During the summer of 2007?
c. - During the week of March 10, 2008?
4. Who stood to benefit from Bear’s implosion?
5. Is market perception of liquidity more important for an investment bank than it is for an traditional manufacturing or distribution business? If so, why? 6. How could Bear have addressed perceptions of its liquidity? Could it have stopped the run on the bank, and if so, how? 7. Did Bear’s failure undermine the viability of so called “pure-play” investment banks? 8. What role should the Fed play in maintaining order in world securities markets? Case: Investment banking in 2008 (B): A brave new world (KEL380)

1. Why were proponents of deregulation so successful in the late 1990s? How much can we blame deregulation for the meltdown in the investment banking industry? And how could the government have foreseen and/or stopped the domino effect before the crisis of 2008? 2. Could any one of the investment banks have remained competitive without following the industry trend of taking on increasing amount of leverage to boost returns on investments? If so, how? 3. Why was Lehman Brothers allowed to fail while Bears Stern was not? 4. Did the compensation structure of investment banking industry encourage executives and employees to take on excessive risk to boost short-term profits? Why or why not? 5. How much of the industry-wide crisis stemmed from investment banks’ financials and current economic climate as opposed to investor panic and speculation? 6. Both Bear and Lehman bailed out their proprietary hedge funds. Did they have any other option? What would have happened had they not done so? 7. Could Morgan Stanley and Goldman Sachs survived without becoming bank holding companies? What were the benefits and disadvantages of becoming bank holding companies? What does designation as bank holding companies mean for the way Morgan and Goldman operate going forward?

Case study: Risk and return analysis
Case: Beta Management Company (9-292-122)

1. What is Wolfe’s current investment strategy? What kind of adjustment is she considering? 2. Calculate the variability (standard deviation) of the stock returns of California REIT (CREIT) and Brown Group (BG) during the past two years. How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest? 3. Suppose Beta’s position had been 99% of equity funds invested in the index fund, and 1% in the individual stock. Calculate the variability of this portfolio using each stock. How does each stock affect the variability of the equity investment, and which stock is riskiest? Explain how this makes sense in view of your answer to Question 2 above. 4. Perform a regression of each stock’s monthly returns on the Index returns to compute the “beta” for each stock. This regression is called the Market Model in the literature. How does this relate to the situation described in Question 3 above? 5. How might the...
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