bear stearns case
1.) Investment Strategies:
The investment strategy of the High Grade Structured Credit Strategies Master Fund was to raise capital from investors and that capital was used to buy “collateralized debt obligations” backed by highly rated subprime mortgage back securities. These CDO’s had a higher rate than that of their borrowing rate, thus, they had added to their expected return by levering more and then buying more CDO’s. To hedge some of the risk of the underlying asset, they bought credit default swaps. If the underlying exposure had a deficit, the swap would offset the loss with a gain. These CDS’s provided some protection against any movements in the credit market (Bear Stearns and the Seeds of its Demise, 2008).
The investment strategy of the High Grade Structured Credit Strategies Enhanced Master Fund was essentially the same as the one above; however, there was a greater investment into low-risk securities. Thus, increasing the amount of leverage to enable this additional investment. This investment would then create a higher return, but with limited risk (Bear Stearns and the Seeds of its Demise, 2008).
2.) Profits 2003-2007:
The profits of these funds from 2003-2007 are shown in the table below. There was a significant decrease in the yields from 2003-2007 because of the collapse of the funds.
Year
CDO yields
Borrowing Costs
(1year LIBOR rates + CDS rates)
Profits from the funds
(CDO – Borrowing Costs)
2003
5.67*1.25= 7.09
1.37+.30=1.67
5.42
2004
5.63*1.25= 7.04
2.19+.36=2.55
4.49
2005
5.24*1.25= 6.55
4.09+.30=4.39
2.16
2006
5.59*1.25= 6.99
5.35+.23=5.58
1.41
2007
5.56*1.25= 6.95
5.17+.79=5.96
.99
3.) Success to Collapse:
The investment strategy was very successful in its early periods because the housing market was very active. Low interest rates allowed an influx of borrowing and higher house prices. This created the need for an investment that could produce a substantial yield and was a “safe”
The investment strategy of the High Grade Structured Credit Strategies Master Fund was to raise capital from investors and that capital was used to buy “collateralized debt obligations” backed by highly rated subprime mortgage back securities. These CDO’s had a higher rate than that of their borrowing rate, thus, they had added to their expected return by levering more and then buying more CDO’s. To hedge some of the risk of the underlying asset, they bought credit default swaps. If the underlying exposure had a deficit, the swap would offset the loss with a gain. These CDS’s provided some protection against any movements in the credit market (Bear Stearns and the Seeds of its Demise, 2008).
The investment strategy of the High Grade Structured Credit Strategies Enhanced Master Fund was essentially the same as the one above; however, there was a greater investment into low-risk securities. Thus, increasing the amount of leverage to enable this additional investment. This investment would then create a higher return, but with limited risk (Bear Stearns and the Seeds of its Demise, 2008).
2.) Profits 2003-2007:
The profits of these funds from 2003-2007 are shown in the table below. There was a significant decrease in the yields from 2003-2007 because of the collapse of the funds.
Year
CDO yields
Borrowing Costs
(1year LIBOR rates + CDS rates)
Profits from the funds
(CDO – Borrowing Costs)
2003
5.67*1.25= 7.09
1.37+.30=1.67
5.42
2004
5.63*1.25= 7.04
2.19+.36=2.55
4.49
2005
5.24*1.25= 6.55
4.09+.30=4.39
2.16
2006
5.59*1.25= 6.99
5.35+.23=5.58
1.41
2007
5.56*1.25= 6.95
5.17+.79=5.96
.99
3.) Success to Collapse:
The investment strategy was very successful in its early periods because the housing market was very active. Low interest rates allowed an influx of borrowing and higher house prices. This created the need for an investment that could produce a substantial yield and was a “safe”
Cited: Bear Stearns and the Seeds of its Demise, UV1064 (October 22, 2008). Retrieved from https://cb.hbsp.harvard.edu/cbmp/content/26588959 Gorton, G., & Metrick, A. (2012). Getting up to Speed on the Financial Crisis: A One‐Weekend‐Reader’s Guide. Retrieved from https://moodle.oakland.edu/pluginfile.php/2286770/mod_resource/content/1/Yale-GortonMetrick12.pdf Cohan, W. (2009). Inside the Bear Stearns Boiler Room. Retrieved from: http://money.cnn.com/2009/03/02/magazines/fortune/cohan_houseofcards_full.fortune/ Gray, A. (2009). The Future of Banking. Retrieved from: https://www.pwc.com/en_TH/th/publications/assets/future-of-banking.pdf