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Tutor profile: Samaksh G.

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Samaksh G.
Quant Tutor for 5 years | Equity Research at J P Morgan |
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Questions

Subject: Economics

TutorMe
Question:

Identify key role players from the inception to the demise of the S&L market Identify and analyze shortfalls of the regulation which affected the S&L market.

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Samaksh G.
Answer:

Prior to Savings and Loans(S&Ls), mortgages payments services were provided by Insurance companies. S&L changed the way mortgages payments were financed. From short term mortgages with a high balloon payment to long term mortgage payments. The long term mortgage payments were affordable and it eventually served its a purpose by increased homeownership in the U.S. Savings and Loans are special types of banks that are created with the goal to increase affordable homeownership. They normally offer higher rates than a typical savings account to attract customers to increase their ability to offer mortgages. They should have normally ¾ of their assets in residential mortgages. The U.S faced high inflation due to taking away the currency from the Gold standard which led to high-interest rates as a precautionary measure. In the 1970s, In the lieu of stagflation and low economic growth combined with high inflation, The Fed Reserve decided to raise the interest rates as a monetary measure leading to a recession in the 1980s. The series of events lead to the devastation of S&Ls. The high-interest rates led to people shifting their savings in banks. Also, recession depleted the demand for households purchasing home. S&L saw a decreasing number of applicant families who wanted to buy a house during the recessionary time. These seriously affected the portfolio of S&Ls and the revenue inflows. The period after 1980 was a fiasco for S&Ls. Federal Home Loan Bank Act which was initiated in the 1930s to provide low-cost funds to banks for mortgages created restrictions on Saving and Loans which included - Interest Rate caps on loans and deposits which handicapped S&L to compete with other lenders in the market which offered higher interest rates. Lending restriction further aggravated this loss of share to banks. Rising interest during the recessionary times also affected by revenue inflows. Pressure from the S&Ls led to the signing of Garn-St. Germain Depository Institutions Act by Ronal Reagan in 1982 which allowed to increase interest rates, and reduce their LTV(Loan to Value ratios) which meant S&Ls could make more consumer loans. The level of insurance was also raised to 100k(Previously 40k per depositor). The Act also allowed S&Ls to make risky investments which were amplified by cutting of budget of the FHLBB(regulatory body). The law leads to increasing in S&Ls assets by 56% during the years 1982-198. Legislators in various states also allowed S&L to use speculative real estate. Another point which got unnoticed then the use of historical accounting in Banks. Historical Accounting involves only the initial price of the assets which are only updated when the assets are sold. In 1986, there was a decrease in prices of oil, which led to a decrease in property prices of S&Ls in Texas but due to the accounting policy, The banks looked they were still going strong as they didn’t depreciate their assets. The laws didn’t do enough to keep S&Ls to stay profitable and soon by 1983, ~9% of them were bankrupt. As the government also can’t support a lot of bankruptcies at one time, they allowed the bad banks to stay open and keep their losses mounting. But it’s was soon when the FSLIC declared it’s bankruptcy and went down. In 1989, George H.W. Bush signed the FIRREA (Financial Institutions Reform, Recovery and Enforcement Act) which provided close to $ 50 B to close the banks. S&Ls' regulations were also revamped which led to bad loans in the book. Resolution Trust corporation was set up to sell the bank assets

Subject: Statistics

TutorMe
Question:

Describe the differences between CAPM and APT. What model would you choose between CAPM and APT? Provide arguments to support your choice.

Inactive
Samaksh G.
Answer:

CAPM is based on the assumption that there is a common mindset among all investors in predicting stock returns which are not the case. Also, there is no perfect proxy to understand the changes in stock. CAPM is that all investors have the same mindset or way of looking at the investment, especially in estimating the expected return of a stock. In the real world, this assumption has a weakness, because no one proxy is sufficient to describe why the return of stock changes. CAPM takes into assumptions of the Portfolio Theory which majorly includes the concept of risk-free assets. The model includes Risk-free assets in the derivation of the Capital Market Line (also referred to as the new efficient frontier). The return on the asset required by the investor (Ri) is derived from the risk-free rate (Rf) and a risk premium(Rm - Rf). The risk premium calculated by multiplying the beta (β)into the risk premium of the asset. APM model, on the other hand, has multiple factors that include non-company factors, which require the asset's beta concerning each separate factor. APM further does not hold the assumption which CAPM holds like : 1. CAPM assumes Portfolio contains all risky assets and has efficient mean and variance while APT does not. 2. The APT model does not assume a Quadratic utility function 3. While CAPM has only beta and one factor PT incorporates multiple factors including non-company factors 4. Generally, APT has fewer assumptions in its theory and can have much more computationally difficult to implement due to the presence of a large number of factors that see fewer assumptions and can be harder to implement than the CAPM.

Subject: Finance

TutorMe
Question:

Give a brief introduction of Global Financial Crisis(2008). Explain it's primary causes and market conditions that led to the crisis?

Inactive
Samaksh G.
Answer:

Similar to all expansion and contraction cycles, the seeds leading to the primary causes of 2008 Global Financial crisis were sown much before. After a mild recession in 2001, the Federal Reserve decreased the fed rate from around 6% (Mid- 2000) to ~2%(Late-2001). The drastic rate cut pumped cheap money in the economy which started to drive up the real estate prices. Also, due to widespread expectations that real estate is safe havens for investments, Banks and other lenders increasingly made risky investments to households. These risky investments asking for loan amounts close to the purchase price of the housing borrowing was done by ‘subprime’ borrowers. These borrowers with unsteady income flows and higher default history were risky, although banks increasingly shelled out loans due to high lending competition in the market on the presumption that the good times would continue. Another factor of not assessing borrowers’ ability in giving out loans was due to ‘Mortgage-Backed Securities’ made up of a bundle of home loans(Asset-Based Security). The instrument was similar to a bond as the investor received periodic payments originating when the mortgage installments of the loans were paid. The Mortgage Backed Securities soon rose to popularity backed by Freddie Mac and Fannie Mae and the rating agencies. When the debts on the subprime borrowers started mounting, the defaults eventually decreased the prices of these MBS and other collateralized debt obligations. The piling losses led to an acute credit crunch with the banks leading to unforeseen insolvency of big lenders and the collapse of the lending market.

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