Finance

To a large degree, finance just means other people's debts

# Definitions & Terms

* The financial market consists of the bond market, stock market, real estate, commodity market, derivatives market, foreign exchange market, money market, spot market, private equity, and the over-the counter market.
* Exposure: Financial exposure is the amount that one stands to lose in an investment (i.e. risk)
* Finance as the system by which credit is created, bought and sold and by which the direction and use of capital is determined
* Money system: exchange rates between currencies
* Stocks, or shares of stock (stock = general term; shares: I have shares of a specific company), represent an ownership (i.e. a ownership certificate/having equity in the firm) in a corporation. Stock is a representation of capital paid or invested into a business entity by stockholders → Thus, I buy shares to be a shareholder and thereby have power over the company
* Bonds are a form of long-term debt in which the issuing corporation promises to pay the principal amount at a specific date (probably plus interest rates). Bonds are tradable
* Loans, tend to be agreements between banks and customers. Loans are usually non tradable
* Clearing (bank): A commercial bank that is part of a network of banks that can clear checks for its clients regardless of whether or not the check originates from the same commercial bank
* An asset is simply a capitalised property title and its value is set in anticipation of either some future stream of revenue or some future state of scarcity

# Securities

* Structured Finance is a type of financing that uses securitization. There are several types of Structured Finance Instruments, some of them are: Credit Derivatives, Collateralized Fund Obligation (CFO), Asset-Backed Security (ABS), Mortgage-Backed Security (MBS), and Collateralized Debt Obligation (CDO).
* Securitization describes the process of pooling financial assets and turning them into tradable securities. The first products to be securitized were home mortgages, and these were followed by commercial mortgages, credit card receivables, auto loans, student loans and many other financial assets.
* Securitization provides financial institutions with a mechanism to remove assets from their balance sheets and increasing the available pool of capital
* It lowers interest rates on loans and mortgages
* It increases liquidity in a variety of previously illiquid financial products by turning them into tradable assets
* In addition to its benefits, securitization has two drawbacks. The first is that it results in lenders that do not hold the loans they make on their own balance sheets. This "originate to distribute" (as opposed to originate-to-hold) business model puts less of an impetus on lenders to ensure that borrowers can eventually repay their debts and therefore lowers credit standards.
* The second problem lies with securitization's distribution of risk among a wider variety of investors. During normal cycles, this is one of securitization's benefits, but during times of crisis the distribution of risk also results in more widespread losses than otherwise would have occurred.
* A security is paper traded for value where profits are anticipated through third-party management.
* A security is a financial instrument that represents an ownership position in a publicly-traded corporation (stock), a creditor relationship with governmental body or a corporation (bond), or rights to ownership as represented by an option. A security is a fungible, negotiable financial instrument that represents some type of financial value. The company or entity that issues the security is known as the issuer.
* In the USA, a security is a tradable financial asset of any kind. Securities are broadly categorized into:
	+ debt securities, (e.g., banknotes, government bonds, corporate bonds, certificates of deposit, CDOs debentures): Debt or bonds give the customer loaner-ship positions; represents money that is borrowed and must be repaid, with terms that define the amount borrowed, interest rate and maturity/renewal date
	+ equity securities, (e.g., common stocks): Equity or stock gives the customer ownership positions in the security; represents ownership interest held by shareholders in a corporation; unlike holders of debt securities who generally receive only interest and the repayment of the principal, holders of equity securities are able to profit from capital gains
	+ derivatives, (e.g., forwards, futures, options and swaps).
* → In practice, the distinction between equity and debt finance has become increasingly blurred. Actual earnings thus become a second order concern to access to liquidity.

## Bonds

* British government bonds are called gilt
* If a corporation or government needs money, they issue bonds (basically IOUs) to borrow money from the lenders (i.e. investors). The interests that the borrower/bond-issuer has to pay are called coupon while the amount to be repaid on the maturity date is called face value/par value/principal. The coupon is expressed as a percentage of the par value. If a bond pays a coupon of 10% and its par value is $1,000, then it'll pay $100 of interest a year. A rate that stays as a fixed percentage of the par value like this is a fixed-rate bond. Another possibility is an adjustable interest payment, known as a floating-rate bond. In this case the interest rate is tied to market rates through an index, such as the rate on Treasury bills.
* Bonds are known as fixed-income securities because you know the exact amount of cash you'll get back if you hold the security until maturity
* **Bonds are debt, whereas stocks are equity.**
* By purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights and the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government). The primary advantage of being a creditor is that you have a higher claim on assets than shareholders do: that is, in the case of bankruptcy, a bondholder will get paid before a shareholder. However, the bondholder does not share in the profits if a company does well - he or she is entitled only to the principal plus interest.
* What confuses many people is that the par value is not the price of the bond. A bond's price fluctuates throughout its life in response to a number of variables (more on this later). When a bond trades at a price above the face value, it is said to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount.
* U.S. government securities, for example, are known as risk-free assets because the government is always able to bring in future revenue through taxes. A company, on the other hand, must continue to make profits, which is far from guaranteed. This added risk means corporate bonds must offer a higher yield in order to entice investors - this is the risk/return trade-off in action
* For market participants who own a bond, collect the coupon and hold it to maturity, market volatility is irrelevant; principal and interest are received according to a pre-determined schedule. But participants who buy and sell bonds before maturity are exposed to many risks, most importantly changes in interest rates. When interest rates increase, the value of existing bonds falls, since new issues pay a higher yield. Likewise, when interest rates decrease, the value of existing bonds rises, since new issues pay a lower yield. This is the fundamental concept of bond market volatility—changes in bond prices are inverse to changes in interest rates. Fluctuating interest rates are part of a country's monetary policy and bond market volatility is a response to expected monetary policy and economic changes.
* Covered bond: A covered bond is a corporate bond with one important enhancement: recourse to a pool of assets that secures or "covers" the bond if the originator (usually a financial institution) becomes insolvent. These assets act as additional credit cover. Covered bonds are debt securities backed by cash flows from mortgages or public sector loans. They are similar in ways to asset-backed securities created in securitization, but covered bond assets remain on the issuer’s consolidated balance sheet (usually with an appropriate capital charge). The covered bonds continue as obligations of the issuer (often a bank); in essence, the investor has recourse against the issuer and the collateral, sometimes known as "dual recourse." Covered bonds are quite transparent. Banks are obliged to report regularly and in detail on the cash flow and substitutions in the asset pools that secure covered bonds
* Yield is a figure that shows the return you get on a bond. The simplest version of yield is calculated using the following formula: yield = coupon amount/price. When you buy a bond at par, yield is equal to the interest rate. When the price changes, so does the yield
* If the price of your bond with a coupon of 10% goes down from $1000 to $800, then the yield goes up to 12.5%. This happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200) → bond's price and its yield are inversely related.
* Another example for the inverse relationship between bond prices and yields: If you buy a bond with a face value of £100 for £95 now, then you are effectively getting a yield of 5.26% because 100/95 = 1.0526, so you are investing your £95 at a rate of 5.26% to turn it into £100 in a year's time. If on the other hand you bought that bond for £98 now, you are getting a yield of 2.04% because 100/98 = 1.0204, you are getting a rate of interest of 2.04%. So this is why when the price of a bond goes up the yield (the rate of interest you are effectively getting by buying it) goes down
* When bond investors refer to yield, they are usually referring to yield to maturity (YTM). YTM is a more advanced yield calculation that shows the total return you will receive if you hold the bond to maturity. It equals all the interest payments you will receive (and assumes that you will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if you purchased at a discount) or loss (if you purchased at a premium).
* The factor that influences a bond more than any other is the level of prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, thereby raising the yield of the older bonds and bringing them into line with newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, thereby lowering the yield of the older bonds and bringing them into line with newer bonds being issued with lower coupons.
* Government Bonds: In general, fixed-income securities are classified according to the length of time before maturity. These are the three main categories:
	+ Bills - debt securities maturing in less than one year.
	+ Notes - debt securities maturing in one to 10 years.
	+ Bonds - debt securities maturing in more than 10 years.
* Marketable securities from the U.S. government - known collectively as Treasuries - follow this guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills). Technically speaking, T-bills aren't bonds because of their short maturity.
* Municipal bonds, known as "munis", are the next progression in terms of risk. Cities don't go bankrupt that often, but it can happen. The major advantage to munis is that the returns are free from federal tax. Furthermore, local governments will sometimes make their debt non-taxable for residents, thus making some municipal bonds completely tax free. Because of these tax savings, the yield on a muni is usually lower than that of a taxable bond
* A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear. Generally, a short-term corporate bond is less than five years; intermediate is five to 12 years, and long term is over 12 years. Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. Variations on corporate bonds include convertible bonds, which the holder can convert into stock, and callable bonds, which allow the company to redeem an issue prior to maturity
* Zero-coupon bond: a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and 10 years to maturity is trading at $600; you'd be paying $600 today for a bond that will be worth $1,000 in 10 years.
* Bonds can either be callable or noncallable. With a callable bond, the issuer has the option to return the investor's principal early, after which the investor receives no more interest payments. Issuers of noncallable bonds lack this option. Consequently, prepayment risk, which describes the chance of the issuer returning principal early and the investor missing out on subsequent interest, is only associated with callable bonds.

### Quantitative easing & bonds

* When the central bank is concerned about the risks of very low inflation, it cuts Bank Rate – that is, it reduces the price of central bank money. But interest rates cannot fall below zero → QE
* The bank creates money and uses it to buy assets such as government bonds and high-quality debt from private corporations. Thus, the central bank buys assets from private sector institutions – that could be insurance companies, pension funds, banks or non-financial firms – and credits the seller’s bank account. So the seller has more money in their bank account, while their bank holds a corresponding claim against the Bank of England (known as reserves). The end result is more money out in the wider economy
* Direct injections of money into the economy, primarily by buying gilts (i.e. UK government bonds), can have a number of effects. The sellers of the assets have more money so may go out and spend it. That will help to boost growth. Or they may buy other assets instead, such as shares or company bonds. That will push up the prices of those assets, making the people who own them, either directly or through their pension funds, better off. So they may go out and spend more. And higher asset prices mean lower yields, which brings down the cost of borrowing for businesses and households. That should provide a further boost to spending
* Why do higher asset prices mean lower yields? → Say a government bond originally costs £100 and yields £10. This £10 yield is fixed. QE leads to the purchasing of these bonds, increasing the demand and so the price of these bonds increases to e.g. £200. This bond now still yields £10 but costs £200, so now yields 5% instead of the original 10% (i.e. again the inverse relation between bond price and bond yield). These lower interest rates on bonds then filter through the system to mortgages, loans and credit cards leading to reduced borrowing rates. How?
* As for how the yield on bonds transfers to interest rates on other forms of borrowing: lets say you want to borrow some money off me and we're negotiating what rate of interest you're going to pay me. Supposing the yield on government bonds was 5%, then if you say you'll offer me 3%, why should I lend my money to you? I could just use that money to buy government bonds and make 5% on it. So that's a starting point for our negotiation. Now if the yield on government bonds was 2%, then of course I'm interested in lending you money at 3%, because that's better for me than what I'd get buying government bonds.

### Repo markets

* Repo markets link securities traders to dealers that offer short term liquidity
* Repo is short for repurchase agreement. Those who deal in government securities use repos as a form of overnight borrowing. A dealer or other holder of government securities (usually T-bills) sells the securities to a lender and agrees to repurchase them at an agreed future date at an agreed price. They are usually very short-term, from overnight to 30 days or more. This short-term maturity and government backing means repos provide lenders with extremely low risk.
* Repos are popular because they can virtually eliminate credit problems. Unfortunately, a number of significant losses over the years from fraudulent dealers suggest that lenders in this market have not always checked their collateralization closely enough

## Collateralized Debt Obligation

* Check out: CDS, CDO and RMBS explained
* One of the most important innovations from Wall Street was the act of pooling loans together to then split up into separate interest bearing instruments. This concept of collateralizing and structured financing predates the market for collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs)
* An asset-backed security (ABS) is a security created by pooling non-mortgage assets that is then resold to investors
* A collateralized debt obligation (CDO) is a complex type of ABS that can be based on non-mortgage assets, mortgage assets or both together. The ABS evolved from mortgage-based securities (MBS), which are created from pools of mortgage assets, typically first mortgages on homes. Rather than mortgages, ABSs are backed by credit card receivables, home equity loans, student loans, auto loans and other non-mortgage financial vehicles.
* CDO is a more general term than MBS. CDO refers to a security where the cashflows from a pool of assets (the "collateral") are used to finance a set of bond payments (the "debt obligation"). The assets need not be mortgages: they can be loans, bonds, credit card receivables, franchise payments, etc. → An MBS is secured only by the mortgage loan while a CDO is secured by several other underlying assets such as corporate loans, MBS, credit card payments, royalties, leases, and other assets used as collateral.
* In contrast to CMOs, CDOs, which came along later in the 1980s, encompass a much broader spectrum of loans beyond mortgages.
* **Regular/Cash CDO**: A CDO is a structured financial product backed by a pool of loans. When a commercial/retail bank approves loans (e.g. mortgages, credit card loans) to individuals, these loans are then sold to investment banks. The investment bank then repackages these loans to form an investment product called the CDO, which is then sold to investors. The principal and interest payments made on the loans are redirected to the investors in the pool. It's called CDO because the pooled assets (mortgages, bonds and loans) are essentially debt obligations that serve as collateral for the CDO → CDOs are sometimes classified by their underlying debt. Collateralized loan obligations (CLOs) are CDOs based on bank loans, for example. Collateralized bond obligations (CBOs) are based on bonds or other CDOs.
* If the underlying loans go bad, the banks transfer much of the risk to the investor, which will typically be a large pension or hedge fund. As a result, banks slice the CDO into various risk levels: the tranches. Senior tranches are the safest because they have the first claim on assets if some the underlying loans default; as a result have a higher credit rating and offer lower nominal yield/coupon rates (=annual interest rate paid on a bond, expressed as a percentage of the face value). Junior tranches are riskier and therefore offer higher interest rates to attract investors. As of 2003, banks used subprime mortgage-backed securities as their main underlying collateral. CDOs subsequently exploded in popularity, with CDO sales rising almost 10-fold from $30 billion in 2003 to $225 billion in 2006. With the popularity of CDOs skyrocketing home lenders received a steady flow of cash and as a result often lent to risky borrowers. When the mortgages then started to default, the CDO dealers started to make huge losses.
* As many as five parties are involved in constructing CDOs:

1. CDO managers, who select the collateral and often manage the CDO portfolios;
2. Securities firms, who approve the selection of collateral, structure the notes into tranches and sell them to investors;
3. Rating agencies, who assess the CDOs and assign them credit ratings;
4. Financial guarantors, who promise to reimburse investors for any losses on the CDO tranches in exchange for premium payments; and
5. Investors such as pension funds and hedge funds.

* **Synthetic CDO**: A synthetic CDO is a variation of a CDO that generally uses credit default swaps and other derivatives to obtain its investment goals/is a form of collateralized debt obligation (CDO) that invests in credit default swaps (CDSs) or other non-cash assets to gain exposure to a portfolio of fixed income assets, i.e. synthetic CDOs are backed by other credit derivatives generate income by selling insurance against bond defaults in the form of credit default swaps.
* A synthetic CDO is typically negotiated between two or more counterparties that have different viewpoints about what will ultimately happen with respect to the underlying reference securities. In this regard, a synthetic CDO requires investors on both sides—those taking a long position and those taking a short position. One counterparty typically pays a premium to another counterparty in exchange for a large payment if certain loss events related to the reference securities occur, similar to an insurance arrangement.
* The value and payment stream of a synthetic CDO is derived not from cash assets, like mortgages or credit card payments — as in the case of a regular or "cash" CDO — but from premiums paying for credit default swap "insurance" on the possibility of default. The synthetic CDO usually references tranches" of subprime home mortgages. Synthetic issuance jumped from $15 billion in 2005 to $61 billion in 2006, when synthetics became the dominant form of CDO's in the US, valued "notionally" at $5 trillion by the end of the year according to one estimate
* **CDO squared**: This is identical to a CDO except for the assets securing the obligation. Unlike the CDO, which is backed by a pool of bonds, loans and other credit instruments; CDO-squared arrangements are backed by a pool of CDOs (i.e. CDO tranches). CDO-squared allows the banks to resell the credit risk that they have taken in CDOs.

## Derivatives

* Derivatives are popular instruments to hedge against an underlying asset. A derivative is a security with a price that is dependent upon or derived from one or more underlying assets (either equity or fixed-income products). The derivative itself is a contract between two or more parties based upon the asset or assets. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. OTC derivatives constitute the greater proportion of derivatives in existence and are unregulated, whereas derivatives traded on exchanges are standardized.
* Participants in a derivative market can be segregated into four sets based on their trading motives:
	+ Hedgers
	+ Speculators
	+ Margin Traders
	+ Arbitrageurs
* The Black Scholes model is a mathematical model of a financial market containing derivative investment instruments. The model gives a theoretical estimate of the price of (European-style) options over time. The key idea behind the model is to hedge the option by buying and selling the underlying asset in just the right way and, as a consequence, to eliminate risk. This type of hedging is called delta hedging and is the basis of more complicated hedging strategies such as those engaged in by investment banks and hedge funds.

### Futures

* A futures contract represents a legally binding (contractual) agreement between two parties, generally made on the trading floor of a futures exchange, to pay or receive the difference between the predicted underlying price set when entering into the contract and the actual price of the underlying when the contract expires → i.e. to buy or sell a particular commodity or financial instrument at a pre-determined price in the future. Stock futures are one way to hedge your investments so that no single market fluctuation -- way up or­ way down -- will ruin your portfolio. In practice, however, stock future contracts are almost never held to expiration date. The contracts are bought and sold on the futures market.
* Index futures trade with a multiplier that inflates the value of the contract to add leverage to the trade. The multiplier for the Dow is 10, for the Nasdaq it is 100 and it is 250 for the S&P. For example, if a Dow Jones Index future is trading at 10,000, this means that if an investor purchased one futures contract, it would be worth $100,000. What this really means for the investor is that every one-point change in the Dow will cause a $10 change in real terms for the investor. If the Dow falls 100 points, the holder of the contract on the long side will lose $1,000.
* The quoted price movements of the futures contracts in early trading is used by some traders as a gauge for how the overall exchanges will perform at market open and over the trading day. If the index future is trading higher before the market opens, it generally means that the actual index will trade up in the early part of the day. This is because the index futures are closely tied to the actual indexes. These futures contracts mirror the underlying index and act as a precursor of the actual exchange index's direction.
* The Chicago Board of Trade at 8:20am EST, just over an hour before the stock market opens for trading.This allows investors to use the futures prices to get a generalized view of market sentiment, and may help to position certain trading strategies before equity markets open.
* When you buy or sell a stock future, you're not buying or selling a stock certificate. You're entering into a stock futures contract -- an agreement to buy or sell the stock certificate at a fixed price on a certain date. Unlike a traditional stock purchase, you never own the stock, so you're not entitled to dividends and you're not invited to stockholders meetings . In traditional stock market investing, you make money only when the price of your stock goes up. With stock market futures, you can make money even when the market goes down.

#### Short & long selling/buying

Short selling (also known as shorting or going short) is the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them ("covering"). In the event of an interim price decline, the short seller will profit, since the cost of (re)purchase will be less than the proceeds which were received upon the initial (short) sale.
To be long in a security, means the holder of the position owns the security and will profit if the price of the security goes up. Going long is the more conventional practice of investing and is contrasted with going short. An options investor goes long on the underlying instrument by buying call options (i.e. the right to later buy the underlying/asset at a now specified price; thus, if we agree that I can buy for $15 and the price of the asset in five months is $50, I will make profits since I can still buy for only $15) or writing put options on it

* What's the difference between a long and short position in the market? → Essentially, when speaking of stocks, long positions are those that are owned and short positions are those that are owed. An investor who owns 100 shares of XYZ stock is said to be long 100 shares. This investor has paid in full the cost of owning the shares. An investor who has sold 100 shares of XYZ stock without currently owning those shares is said to be short 100 shares. The short investor owes 100 shares at settlement and must fulfill the obligation by purchasing the shares in the market to deliver. Oftentimes, the short investor borrows the shares from a brokerage firm in a margin account to make the delivery. Then, with hopes the stock price will fall, the investor buys the shares at a lower price to pay back the dealer who loaned them.

When an investor uses option contracts in an account, long and short positions have slightly different meanings.

* That is, there are two basic positions on stock futures: long and short. The long position agrees to buy the stock when the contract expires. The short position agrees to sell the stock when the contract expires. If you think that the price of your stock will be higher in three months than it is today, you want to go long. If you think the stock price will be lower in three months, then you'll go short.
* **Buying on margin**: The chief advantage of stock futures is the ability to buy on margin. Investing on margin is also called leveraging, since you're using a relatively small amount of money to leverage a large amount of stock. For example, if you have $1,000 to invest, you can by 10 shares of IBM stock. But with the same $1,000, you can buy a futures contract for 50 shares of IBM stock. It's true that you can also buy traditional stock on margin, but the process is much more complicated. When buying stock on margin, you're essentially taking out a loan from your stockbroker and using the purchased stock as collateral. You also have to pay interest to your broker for the loan.
* Single stock futures can be risky investments when purchased as standalone securities. There's a possibility of losing a significant chunk of your initial investment with only minimal market fluctuations. However, there are several strategies for buying stock futures, in combination with other securities, to ensure a safer overall return on investment.

One of the most effective stock future strategies is called hedging. The basic idea of hedging is to protect yourself against adverse market changes by simultaneously taking the opposite position on the same investment

* Check out the 2010 Flash Crash indicative of the turbulence of financial markets

### Swaps

#### Credit default swap

* In contrast to standard insurance, which one purchases on an entity one owns (a house, a life) CDS allow one to ensure what one does not own – namely the risk of someone else’s loan defaulting.

#### Interest rate swap

* An interest rate swap (IRS) is a liquid financial derivative instrument in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate (or vice versa) or from one floating rate to another; an agreement in which one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps usually involve the exchange a fixed interest rate for a floating rate, or vice versa, to reduce or increase exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would have been possible without the swap.

## Trading Jargon

* Positive feedback loop: stock price decline leading to more selling of stock. If the Dow, for example, fell 3%; it might suggest that investors should sell 20% of their portfolio
* Negative feedback loop: a trader sells stocks as they rose and buy them as they declined
* Puts: the option to sell their investments at pre-determined prices
* To go long: buy a futures contract - "to go short" = to sell
* Front running: Front running works when a large purchase of a security for customers will increase the price of the security. Thus, placing one’s own small order at the lower price in “front” of the large order and then reselling at the higher price “behind” the large order, guarantees a positive individual gain on the transaction at the expense of market participants taken collectively. Put differently, it is a stockbroker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers (i.e. either buys for its own account before filling customer buy orders that drive up the price, or sells for its own account before filling customer sell orders that drive down the price)

## Foreign exchange reserves

* Foreign exchange reserves: Foreign-exchange reserves (also: reserve assets or FX reserves) are assets held by a central bank or other monetary authority, usually in various reserve currencies, mostly the US $, and to a lesser extent the euro, the pound sterling, the Japanese yen, and used to back its liabilities—e.g., the local currency issued, and the various bank reserves deposited with the central bank by the government or by financial institutions.

In a strict sense, foreign-exchange reserves should only include foreign banknotes, foreign bank deposits, foreign treasury bills, and short and long-term foreign government securities. However, the term in popular usage commonly also adds gold reserves, special drawing rights (=supplementary FX reserve assets defined and maintained by the IMF), and International Monetary Fund (IMF) reserve positions.
FX reserves are usually an important part of the international investment position of a country.

* Theoretically, in a pure flexible exchange rate regime or floating exchange rate regime, the central bank does not intervene in the exchange rate dynamics; hence the exchange rate is determined by the market and FX reserves are not necessary (other instruments of monetary policy for targeting inflation: interest rates).

On the contrary, a central bank that implements a fixed exchange rate policy may face a situation where supply and demand would tend to push the value of the currency lower or higher (an increase in demand for the currency would tend to push its value higher, and a decrease lower) and thus the central bank would have to use reserves to maintain its fixed exchange rate. Thus, FX reserves can be used to defend a weak currency (a currency in low demand). Hence, the higher the reserves, the higher is the capacity of the central bank to smooth the volatility of the Balance of Payments (i.e. interventions to counter disruptive short-term movements that may include speculative attacks) and assure consumption smoothing in the long term.
→ As seen above, there is an intimate relation between exchange rate policy (and hence reserves accumulation) and monetary policy.

## Leveraged buyout

* A leveraged buyout is a transaction when a company or single asset (e.g., a real estate property) is purchased with a combination of equity and significant amounts of borrowed money, structured in such a way that the target's cash flows or assets are used as the collateral (or "leverage") to secure and repay the borrowed money. That is it is a business model to take over a company by means of having investors (banks, insurance companies, pensions, foundations etc.)pay into a private equity fund, which is supposed to invest the money for them. The fund then borrows a multiple of the initial capital (i.e. leverages). As financial sponsors increase their returns by employing a very high leverage (i.e., a high ratio of debt to equity), they have an incentive to employ as much debt as possible to finance an acquisition. This has, in many cases, led to situations in which companies were "over-leveraged", meaning that they did not generate sufficient cash flows to service their debt, which in turn led to insolvency or to debt-to-equity swaps in which the equity owners lose control over the business to the lenders.

* With this amount of capital (oftentimes billions) the fund then acquires companies (i.e. by buying shares whose stock values are currently low. The credits that had to be taken to take over the firm are transferred/imposed on the company (which also serves as collateral for the credits). That is, the company buys itself and in so doing becomes indebted. During the process the funds managers often receive big bonuses for consulting and the company has to pay interest on the credits. Then the company is restructured, split up etc. to make it profitable for selling it at a later point in time.

# Investment

## Investor types

* Institutional investors: An institutional investor is a nonbank person or organization that trades securities in large enough share quantities or dollar amounts that it qualifies for preferential treatment and lower commissions; usually manage funds on behalf of others; includes banks, insurance companies, pensions, hedge funds, REITs, investment advisors, endowments, and mutual funds

### Funds

* The evolution of the asset management sector reflects some of the broader trends that have affected financial markets as a whole, notably the impact of extraordinary monetary policy operations. As investors have reached for yield in an environment of exceptionally low interest rates, they have sought out asset managers and funds that offer exposures to higher yielding, less actively-traded asset classes
* Mutual fund: classified by their principal investments as money market funds, bond or fixed income funds, stock or equity funds, hybrid funds or other; funds may also be categorized as index funds, which are passively managed funds that match the performance of an index, or actively managed funds; in the US, the share of corporate bonds owned by mutual funds and ETFs has grown from 6% to 17% during 2008-2015
	+ Open-end fund: collective investment scheme which can issue and redeem shares at any time; an investor will generally purchase shares in the fund directly from the fund itself rather than from the existing shareholders. It contrasts with a closed-end fund, which typically issues all the shares it will issue at the outset, with such shares usually being tradable between investors thereafter; Global assets under management of the open-ended mutual fund segment, that excludes ETFs and institutional funds, has increased from $18 trillion in 2009 to $31 trillion in 2015
		- Exchange-traded fund: usually designed to track an equity index or a bond index. For example, the SPDR S&P 500 ETF trust is designed to provide investors with the return they would earn if they invested in the 500 stocks that constitute the S&P 500 index; open-end funds or unit investment trusts that trade on an (stock); holds assets such as stocks, commodities, or bonds and generally operates with an arbitrage mechanism designed to keep it trading close to its net asset value; lower transaction and management costs because ETF distributors only buy or sell ETFs directly from or to authorized participants, which are large broker-dealers
	+ A closed-end fund: is a collective investment model based on issuing a fixed number of shares which are not redeemable from the fund; Unlike open-end funds, new shares in a closed-end fund are not created by managers to meet demand from investors. Instead, the shares can be purchased and sold only in the market. This is the original design of the mutual fund which predates open-end mutual funds but offers the same actively managed pooled investments
	+ Unit investment trust: exchange-traded mutual fund offering a fixed (unmanaged) portfolio of securities having a definite life. Unlike open-end and closed-end investment companies, a UIT has no board of directors

# Money

* Money is debt symbols/debt tokens which exchanged (and debt is made out of nothing, created by an agreement)
* Money is not a thing, it is simply created by these ingredients: mutual trust, a system of accounting and debt symbol
* Money is a special kind of IOU that is universally trusted
* Money, the most mysterious institution of capitalist modernity, served to defuse potentially destabilizing social conflicts, at first by means of inflation, then through increased government borrowing, next through the expansion of private loan markets, and finally (today) through central bank purchases of public debt and bank liabilities
* Money serves three primary functions
	+ Medium of exchange
	+ Unit of account
	+ Store of value

## How money is created

* Seignorage (the difference between the production cost and face value of a $ bill) is going to the central bank/treasury
* The vast majority of virtual money is created by commercial banks. Only ~3% of money in circulation is physical, the rest virtual
* "Money creation is an accounting trick: banks don't lend money, they create it. When a bank gives out a loan, it basically pretends that you have deposited the money...it has to invent the liability...this is how the money supply is created" (Richard Werner)
* When banks make loans they create additional deposits for those that have borrowed the money (Paul Tucker, Bank of England)
* Hence, when everybody starts saving, the money supply shrinks and you get a recession

## Mehrling's hierarchy of money

* The meaning of money is contingent on your standing in the hierarchy of the monetary/credit system → what looks as money at the lowest level is merely credit for the upper levels
* Under a gold standard, gold is the ultimate money and national currencies are a form of credit in the sense that they are promises to pay gold (banks' reserves are not equal to gold but simply a 'proof' that the issuer can fulfill his promise). Farther down the hierarchy, bank deposits are promises to pay currency on demand and securities are promises to pay currency (or deposits) over some time horizon in the future, so they are even more attenuated promises to pay
* For ordinary people like us, bank deposits are the means of settlement. Hence we might be inclined to view deposits (and everything above them) as money, and securities as credit
* For a country settling its accounts, national currency is of limited value. What other countries want is their own currency, or the international means of settlement, which means gold in the case of a gold standard, or perhaps SDRs (Special Drawing Rights at the IMF) in the modern case
* Think of the different layers of the hierarchy as a matter of the qualitative difference between various financial instruments as well as a matter of the relationship between the various financial institutions that issue those instruments:

* Thus, all of the instruments except gold appear as both assets and liabilities (i.e. every liability is someone else‟s asset). They are thus clearly all forms of credit.

## Why Money In The First Place?

* A universal measure for goods and services with which you can calculate
* It's exchangeable and accepted by all salespeople
* It's storable (i.e. won't decay) and can be traded at a later point in time (i.e. when prices are low)
* It's light-weight as opposed to money in the form of goods (e.g. corn, cattle)

## Historical Roots

* Initially, the number on a note designates the equivalent in precious metals. Thus, it can always be exchanged at the bank.
* Nowadays, the monetary value is real only by virtue of the central bank's promise to care about stability. If the central bank is unsuccessful in keeping the money in circulation in relation to the real economy, devaluation or dropping prices might be the consequence.

# Banking

* Banks turn short-term liabilities into long-term assets
* Think of banks as a special kind of security dealer that stands ready to buy or sell a deposit at a given price in terms of currency
* The principal financial intermediaries fall into three categories
	+ Banks—commercial banks, savings and loan associations, mutual savings banks, and credit unions
	+ Contractual savings institutions— life insurance companies, fire and casualty insurance companies, and pension funds
	+ Investment intermediaries—finance companies, mutual funds, and money market mutual funds.

## Fractional reserve banking

Fractional-reserve banking is the practice whereby a bank accepts deposits, makes loans or investments, and holds reserves that are a fraction of its deposit liabilities. Reserves are held at the bank as currency, or as deposits in the bank's accounts at the central bank. Fractional-reserve banking is the current form of banking practiced in most countries worldwide.

## Central bank

* The central bank effectively issues the government’s IOUs and the government guarantees the central bank notes’ value by accepting them for tax payments.
* Central bank liquidity swap is a type of currency swap used by a country's central bank to provide liquidity of its currency to another country's central bank, i.e. provide liquidity in U.S. dollars to overseas markets (read: being provided a 'swap line' by the Fed)
* Extend the same idea from above (banks as security dealer) to the central bank which, under a gold standard, stands ready to buy or sell currency in terms of gold. Both banks and central banks are thus like specialized types of security dealers, quoting prices at which they are willing to convert credit into money and vice versa
* The central bank exploits its position at the top of the hierarchy, i.e. the fact that its own liabilities are more money-like than the liabilities of anyone below it
* The central bank has the ability to issue the government’s currency: reserves and currency in circulation
* Commercial banks have reserves in their account with the Central Bank. The Central Bank can lend reserves to commercial banks in need of liquidity
* The central bank can influences the commercial bank system by setting the interest rate that depositor commercial banks receive for reserves which have in the Central Banks’account and by setting the interest rates at which it lends reserves to commercial banks, and the

### The Fed

* *Why do we need the Fed?* → Sometimes, in order to understand why you need something, it helps to find out what it was like before that "something" was created. Before the Federal Reserve was created in 1913, there were over 30,000 different currencies floating around in the United States. Currency could be issued by almost anyone

he Fed's original job was to organize, standardize and stabilize the monetary system in the United States. It had to set up a method that could create "liquidity" in the money supply - in other words, make sure banks could honor withdrawals for customers. It also needed to come up with a way to create an "elastic currency," meaning it had to control inflation by making sure prices didn't climb too quickly, and it needed a way of increasing or decreasing the country's supply of currency in order to prevent inflation and recession.

* *Inflation* → when inflation is high, things cost more and people spend less. They also do less long-term planning that involves spending money, such as building houses and investing.

*Recession* → When recession hits, the Fed can lower interest rates in order to encourage people to borrow money and make purchases. This works in the short run, but it has to be handled carefully so that inflation isn't impacted in the long run.

* *Fed tasks* → The Fed regulates financial institutions, acts as the U.S. government's bank, acts as a bank's bank, and is responsible for managing the nation's money. The Fed has two divisions: One group, the Board of Governors, is responsible for setting monetary policy and managing the nation's money; the other group, the 12 regional Reserve Banks, acts as the service division that carries out the policy and oversees financial institutions. The regional Reserve Banks represent the private sector. Both of these groups have the same goals.
* *Money manager* → In its role as money manager, the Fed has two primary goals: Maintain stable prices (control inflation) & ensure maximum employment and production output.

*Monetary policy* → The Fed can indirectly influence demand: if interest rates are lowered, borrowing money to make purchases becomes less expensive, and people are more motivated to spend money because they can get a better deal on the loan. Spending money, in turn, stimulates economic growth. If there is too much money in the economy, however, people spend more money and demand increases at a faster rate than supply can match. Prices rise too quickly because of the shortage of products, and inflation results.

* *Financial Institution Regulator* → As a regulator for financial institutions, the Fed establishes the rules of conduct that these institutions must follow. The regional Reserve Banks then carry out the supervision and enforcement of these regulations. These regional banks monitor the activities of banks within their regions and ensure that they are operating appropriately. The Federal Reserve also watches out for the public interest by monitoring banks that are seeking to merge with other banks or holding companies. The Fed rules on these requests according to the impact the merger will have on the local community and general public interest.
* *The Government's bank* → The Fed maintains the checking account of the U.S. Treasury. As the largest bank customer in the country, the U.S. government does quite a bit of business and performs a lot of financial transactions, all of which are handled by the Fed. These transactions amount to trillions of dollars and include all of the tax deposits and withdrawals for U.S. citizens. It also includes securities such as savings bonds, Treasury bills, notes, and bonds that are bought by and for the U.S. government. Coin and paper currency produced by the U.S. Treasury's Bureau of the Mint and Bureau of Engraving and Printing is distributed to financial institutions by the Fed as part of its role as the government's bank.

## Interbank lending

The interbank lending market is a market in which banks extend loans to one another for a specified term. Most interbank loans are for maturities of one week or less, the majority being overnight. Such loans are made at the interbank rate

* The overnight rate is generally the interest rate that large banks use to borrow and lend from one another in the overnight market
* The LIBOR–OIS spread is the difference between LIBOR and the overnight indexed swap rates. The spread between the two rates is considered to be a measure of health of the banking system. It is an important measure of risk and liquidity in the money market, considered by many, including former US Federal Reserve chairman Alan Greenspan, to be a strong indicator for the relative stress in the money markets. A higher spread (high Libor) is typically interpreted as indication of a decreased willingness to lend by major banks, while a lower spread indicates higher liquidity in the market. As such, the spread can be viewed as indication of banks' perception of the creditworthiness of other financial institutions and the general availability of funds for lending purposes.

## Shadow banking

* The shadow banking system is a term for the collection of non-bank financial intermediaries that provide services similar to traditional commercial banks but outside normal financial regulations; the financial intermediaries involved in facilitating the creation of credit across the global financial system but whose members are not subject to regulatory oversight (e.g. hedge funds & unlisted derivatives) while examples of unregulated activities by regulated institutions include credit default swaps
* The shadow banking system has escaped regulation primarily because it does not accept traditional bank deposits. As a result, many of the institutions and instruments have been able to employ higher market, credit and liquidity risks, and do not have capital requirements commensurate with those risks
* Unlike the traditional banking system, which kept mortgages on the banks’ books until maturity, funding them with deposits that grew slowly, the shadow banking system was highly scalable.
* Examples of important components of the shadow banking system include securitization vehicles, asset-backed commercial paper [ABCP] conduits, money market funds, markets for repurchase agreements, investment banks, mortgage companies, payday lenders, private equity funds, insurance companies, all of which are a significant and growing source of credit in the economy.
* The sector has grown significantly, with more than $25 trillion in funds flowing through the system in 2015. Shadow banking constituted roughly 10% of the financial intermediation sector in 1980; by 2008 it was more than half of it at 60%.
* Most of the activity centers around the creation of collateralized loans and repurchase agreements used for short-term lending between nonbank institutions and broker-dealers.
* The shadow banking system had the means to create a lot of “parking space” for foreign money. Securitisation can manufacture large amounts of AAA rated securities provided there is readily available raw material, that is, assets that one can pool and tranche. The United States did have a large latent pool of assets: housing. Any house that was debt-free or underleveraged was potential raw material for securitisation.
* Collateral has been called the cash of shadow banking

# Credit & debt

## How credit & debt works

* When a hunter and a farmer want to exchange products through barter they face different problems. The hunter may have shot a deer while the farmer still has to wait for the next season to be able to barter with carrots. Thus, the two agree that the hunter lends/advances the deer and the farmer will repay the hunter once he has the carrots. The deal will include relevant information about the repay such as: amount, date, form, interest. The two exchange a clay tablet with this information. Now, the two might engage in other deals until A owes B, B owes C, and C owes A so that everyone is owing each other something. Instead of always exchanging the clay tablets, central clearing becomes possible: the individuals deposit their clay tablets in the central bank (which will also make sure the rules are abode by) and merely the ownership of the clay tablets changes.
* In fact, when the bank gives me a consumption loan, it just creates more money by printing it/changing digits. When I then go the the car dealer and pay with my credit card, it is essentially the bank that transfers the just created money to the dealer. The dealer, in turn, can use this money as a very material thing to buy a house etc. In fact, loans create savings (e.g. the dealer's saving)
* Capitalism always produces a surplus. If growth is impeded, over-accumulation occurs. Over-accumulation is any situation in which the surplus that capitalists have available to them cannot find an outlet (happens e.g. through labour constraints, market constraints, resource constraints, technology constraints). After the 1970s, capitalism required a set of international financial institutions that would facilitate capital movement, i.e. a "spatial fix": Surplus capital is shifted abroad rather than accumulated at home. The financialization that occurred became an end in itself → new markets emerging in the 1990s in currency derivatives, interest rate swaps, etc. They grew from almost nothing in 1990 to about three times the output of the global economy in 2006. The explosion of credit that accompanied this also helped capitalists to hold down wages.
* Crisis of late 1960s-1970s: the power of labour emerges and breaking the power of labour became terribly important → partly done by migration policies, by outsourcing and offshoring & by political attacks (Reagan & Thatcher). By 1985 the power of labour had effectively been broken.
* Since the 1970s: Wage repression, in which real wages don't really rise at all. However, this leads to reduced aggregate demand. The solution was credit cards! Household debt in the US has tripled in the last 20 years or so.
* The financial institutions have been operating on both sides - the production and the consumption of housing.

### Mehrling (2011) on credit

* In expansion mode , credit becomes available even to marginal borrowers, while in contraction mode marginal borrowers must repay and only the best borrowers are able to refinance their positions. Second, and more subtle, is the fluctuation of the quality or 'moneyness' of any given type of credit. In expansion mode, the best borrowers within any level of the system find their liabilities treated as close substitutes for the liabilities of those one level higher, i.e. as money, not credit. And then, in contraction mode, differentiation returns.
* At the business cycle frequency, the phenomena surrounding this expansion (i.e. elasticity) and contraction (i.e. scarcity) are grouped under the headings “irrational exuberance” in the expansion phase and “financial crisis” in the contraction phase. In the expansion phase, the qualitative difference between credit and money becomes attenuated; credit expands while the hierarchy flattens. In the contraction phase, the distinction between more money-like and less money-like forms of credit is re-established; credit contracts while the hierarchy steepens
* The history of monetary history consists of a dialogue between two points of view: the Currency Principle (emphasize importance of scarcity) versus the Banking Principle (emphasize importance of elasticity)
* The elasticity comes from the fact that agents at any particular level in the hierarchy can, by their own actions, increase the quantity of credit at their own level, and also the quantity of money for the levels below them
* The key is to appreciate the institutions that, at each level of the hierarchy, act as market makers exchanging credit for money and vice versa
* In liquidity crises, everyone wants money and no one wants credit. Fortunately, what counts as money at one level in the system is merely credit for the level above. This means that higher levels of the system can generally solve the crisis of levels below them. Small crises can be solved by monetary expansion at the immediately higher level
* As always, expansion was followed by contraction, and flattening of the hierarchy by reassertion of differentiation between money and credit. This time is different in detail because of financial globalization and the attendant replacement of a bank-loan-based credit system by a capital-market-based credit system

## Credit cards

* **Universal default**: Even if you make your credit card payments on time, the credit card bank can raise your interest rate automatically if you're late on payments elsewhere -- such as on another credit card or on a phone, car, or house payment -- or simply because the bank feels you have taken on too much debt. This practice is called the "universal default" clause and increasingly is becoming a standard clause in credit card agreements. According to credit card executives, the logic behind universal default is that the bank is not being unreasonable in raising rates when it has reason to believe that the risk of being repaid by the customer has increased. Credit card banks can now easily track your everyday financial activities and monitor your credit score.
* **Credit score**: Your credit score - known as a FICO score - has become a vital statistic for many Americans and can be widely shared. It is used to determine how much you can borrow, how much you pay for life insurance, if you can rent a home, and, as already noted, it can be a factor in determining the interest rate you pay on a credit card. Your credit score is usually determined by five factors, with the most important being the amount you currently owe and your payment history on large debts. It's estimated by credit industry experts that roughly 75 percent of the U.S. population that is eligible for credit (i.e. 18 years or older), have a credit rating score at any given time that indicates the individual's credit worthiness to take out a loan, a mortgage, etc.
* **Fees**: There is no limit on the amount a credit card company can charge a cardholder for being even an hour late with a payment. In 1996, the U.S. Supreme Court in Smiley vs. Citibank lifted the existing restrictions on late penalty fees. Back then, fees ran to $5 or $10, and usually did not exceed $15. After the Court's decision, fees soared, reaching upwards of $30. Since then, the amount of revenue the companies generate from fees (including late charges, over-the-limit fees, and charges for returned checks) has doubled. Duncan MacDonald, one of the lawyers who worked on the Smiley case, predicts penalty fees could rise to $50 in another year.
* **The Credit Reporting System**: Americans' financial habits are monitored by one or more of the three national credit reporting agencies (CRAs): Equifax, Experian, and TransUnion. Every month, financial institutions or creditors send the CRAs credit files which include consumers' account numbers, their types of credit (e.g. mortgages, credit card loans, automobile loans), their outstanding balances, collection actions taken against them, and their bill-payment histories.

## Big credit card companies

* MBNA: MBNA Corporation was a bank holding company and parent company of wholly owned subsidiary MBNA America Bank, N.A., headquartered in Wilmington, Delaware, prior to being acquired by Bank of America in 2006. It was the world's largest independent credit card issuer, specializing in affinity cards.

# Currencies

## The exorbitant privilege

* The term exorbitant privilege refers to the alleged benefit the United States has due to its own currency (i.e., the US dollar) being the international reserve currency. Accordingly, the US would not face a balance of payments crisis, because it purchased imports in its own currency.

Academically, the exorbitant privilege literature analyzes two empiric puzzles, the position and the income puzzle. The position puzzle consists of the difference between the (negative) U.S. net international investment position (NIIP) and the accumulated U.S. current account deficits, the former being much smaller than the latter. The income puzzle consists of the fact that despite a deeply negative NIIP, the U.S. income balance is positive, i.e. despite having much more liabilities than assets, earned income is higher than interest expenses.

* In the Bretton Woods system put in place in 1944, U.S. dollars were convertible to gold. In France, it was called "America's exorbitant privilege" as it resulted in an "asymmetric financial system" where foreigners "see themselves supporting American living standards and subsidizing American multinationals". As American economist Barry Eichengreen summarized:"It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one".In February 1965 President Charles de Gaulle announced his intention to exchange its U.S. dollar reserves for gold at the official exchange rate. He sent the French Navy across the Atlantic to pick up the French reserve of gold and was followed by several countries. As it resulted in considerably reducing U.S. gold stock and U.S. economic influence, it led U.S. President Richard Nixon to end unilaterally the convertibility of the dollar to gold on August 15, 1971 (the "Nixon Shock"). This was meant to be a temporary measure but the dollar became permanently a floating fiat money and in October 1976, the U.S. government officially changed the definition of the dollar; references to gold were removed from statutes.

# Key players in finance

* BlackRock: BlackRock has a stake in every FTSE 100 company, worth a total of £145bn. That means it owns nearly 8% of the UK’s leading share index. Its investment in the FTSE 100 accounts for around 3.5% of its total assets of £4trn. Its biggest stake by value is its £9bn investment in HSBC. It is the biggest shareholder in more than half of the FTSE 100’s companies. [1]

→ check out Goldman Sachs in Europe's elite circles

* Nicholas Brady
	+ 1988-1993 US Secretary of the Treasury under Reagan & George H. W. Bush
	+ Brady Plan in March 1989 (help developing countries which are close to debt default to sell their dollar-denominated bonds)
	+ Chairman of the Board of Dillon Read & Co. Inc. (investment banking)
	+ Bilderberg Group member, trustee of Rockefeller University, member of Council on Foreign Relations

* Stephen Schwarzman
	+ Founder of Blackstone Group (in 1985 with former US Secretary of Commerce Pete Peterson)
	+ Managing director at Lehman Brothers with 31 years & head of Lehman Brothers' global mergers and acquisitions team
	+ Yale & HS
	+ Estimated wealth $13 billion

* Kenneth Griffin
	+ Founder & CEO of Citadel, a global investment firm. With an estimated $25 billion in investment capital as of March 2015, Citadel is one of the world's largest alternative investment management firms

* Richard Fuld
	+ Chairman and Chief Executive Officer of Lehman Brothers from 1994-2008
	+ Began his career at Lehman in 1969
	+ Congress grills Lehman CEO on compensation

* Peter George Peterson
	+ Chairman & CEO of Lehman Brothers 1973-1984
	+ Chair of the Federal Reserve Bank of New York 2000-2004
	+ University of Chicago

* Mario Draghi
	+ PhD from MIT, then professor at the University of Florence from 1981-1994, in 2001 a fellow of the Harvard John F. Kennedy School of Government
	+ From 1984 to 1990 he was the Italian Executive Director at the World Bank, and from 1991-2001 general director of the Italian Treasury
	+ From 2002-2005: vice chairman and managing director of Goldman Sachs International and a member of the firm-wide management committee
	+ Member of the Group of 30 (founded by Rockefeller Foundation)

* Alan Greenspan
	+ Chairman of the Fed 1987-2006
	+ NY University & Columbia University
	+ Corporate director for Aluminum Company of America; Automatic Data Processing; Capital Cities/ABC, Inc.; General Foods; J.P. Morgan & Co.; Morgan Guaranty Trust Company; Mobil Corporation; and the Pittston Company

* Bern Bernanke
	+ Chairman of the Fed from 2006-2014
	+ Chairman of President George W. Bush's Council of Economic Advisers
	+ Hearing before Republican Alan Grayson

* Henry Paulson
	+ Secretary of Treasury 2006-2009
	+ CEO of Goldman Sachs 1999-2006
	+ HBS

* Sandy Weill
	+ Chairman of "Cogan, Berlind, Weill & Levitt"/later "Shearson Loeb Rhoades" (country’s second largest securities brokerage firm) from 1965-1984
	+ First building up Travelers Group Inc. (an insurance company) by a couple of M&As and than merger with Citicorp to become the CEO and chairman of Citigroup 1998-2006 → notwithstanding Glass–Steagall Act, which had kept banking and insurance businesses separate
	+ Weill's office holds a wood etching of him engraved with the words "The Shatterer of Glass–Steagall"

* Robert Rubin
	+ Spent 26 years (1966-1992) at Goldman Sachs, eventually serving as a member of the board and co-chairman from 1990 to 1992
	+ Joined the Clinton administration in 1993 and became Secretary of the Treasury 1995-1999
	+ Joined Citigroup as a board member in 1999 and served temporarily as its chairman in 2007 ($125 billion compensation for that)
	+ In 1997, Rubin and Federal Reserve chairman Alan Greenspan strongly opposed giving the Commodity Futures Trading Commission oversight of over-the-counter credit derivatives when this was proposed by Brooksley Born, the head of the CFTC
	+ Rubin and his deputy Lawrence Summers also steered through the 1999 repeal of the Glass–Steagall Act (1933), which had separated investment banking from the retail side (banking giant Citicorp merged with insurance icon Travelers Group in 1998!)
	+ As of 2007 Chairperson of the Council on Foreign Relations; member of board of directors of Ford Motor Company; member of the Harvard Corporation

* Lawrence Summers

* Paul Volcker
	+ Chairman of the Fed under Jimmy Carter & Ronald Reagan from 1979-1987
	+ Chairman of the Economic Recovery Advisory Board under Barack Obama from 2009-2011
	+ Princeton, Harvard, LSE

* Lloyd Blankfein
	+ CEO & Chairman of Goldman Sachs as of 2006
	+ Harvard

* Wen Jiabao
	+ Premier of the People's Republic of China 2003-2013
	+ leading figure behind Beijing's economic policy

* Phil Gramm
	+ Democratic Congressman (1979–1983)
	+ Republican Congressman (1983–1985), Republican Senator (1985–2002) from Texas
	+ later a lobbyist for UBS
	+ senior economic adviser to John McCain's presidential campaign
	+ responsible for Gramm-Leach-Bliley Act: known for repealing portions of the Glass–Steagall Act, which had regulated the financial services industry → i.e. brought down the walls separating the commercial banking, investment and insurance industries)
	+ Gramm's support was later critical in the passage of the Commodity Futures Modernization Act of 2000 (kept derivatives transactions, incl. credit default swaps, free of government regulation)

* John Meriwether
	+ Bond trader aat Salomon Brothers
	+ Hedge fund executive of Long Term Capital Management, seen as a pioneer of fixed income arbitrage
	+ University of Chicago

# Hyman Minsky's financial instability hypothesis

Minsky argued that a key mechanism that pushes an economy towards a crisis is the accumulation of debt by the non-government sector. He identified three types of borrowers that contribute to the accumulation of insolvent debt:

* hedge borrowers: The "hedge borrower" can make debt payments (covering interest and principal) from current cash flows from investments.
* speculative borrowers: For the "speculative borrower", the cash flow from investments can service the debt, i.e., cover the interest due, but the borrower must regularly roll over, or re-borrow, the principal
* Ponzi borrowers: The "Ponzi borrower" borrows based on the belief that the appreciation of the value of the asset will be sufficient to refinance the debt but could not make sufficient payments on interest or principal with the cash flow from investments; only the appreciating asset value can keep the Ponzi borrower afloat.

If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments

Economist Paul McCulley described how Minsky's hypothesis translates to the subprime mortgage crisis. McCulley illustrated the three types of borrowing categories using an analogy from the mortgage market: a hedge borrower would have a traditional mortgage loan and is paying back both the principal and interest; the speculative borrower would have an interest-only loan, meaning they are paying back only the interest and must refinance later to pay back the principal; and the ponzi borrower would have a negative amortization loan, meaning the payments do not cover the interest amount and the principal is actually increasing. Lenders only provided funds to ponzi borrowers due to a belief that housing values would continue to increase. McCulley writes that the progression through Minsky's three borrowing stages was evident as the credit and housing bubbles built through approximately August 2007. Demand for housing was both a cause and effect of the rapidly expanding shadow banking system, which helped fund the shift to more lending of the speculative and ponzi types, through ever-riskier mortgage loans at higher levels of leverage. This helped drive the housing bubble, as the availability of credit encouraged higher home prices

# Further material

* Global Finance Kurs RUG
* Goldman Sachs - Die Anstalt 13.11.2012

# References

1. ↑  http://www.investopedia.com/ask/answers/100314/whats-difference-between-long-and-short-position-market.asp
2. ↑  http://money.howstuffworks.com/personal-finance/financial-planning/stock-future2.htm
3. ↑  http://www.investopedia.com/terms/b/buying-on-margin.asp
4. ↑  http://money.howstuffworks.com/fed7.htm
5. ↑  http://socialistreview.org.uk/335/interview-david-harvey-exploring-logic-capital
6. ↑  https://en.wikipedia.org/wiki/Exorbitant\_privilege
7. ↑  http://www.independent.co.uk/news/business/analysis-and-features/what-price-the-new-democracy-goldman-sachs-conquers-europe-6264091.html