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September 12 2013 ec250.docx

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September 12 2013 ec250 If central bank produces too much money = inflation (example of Spain) -read his blogs because exam questions would have it Developments in the financial sector slide -the more deposits you put in a house the lesser interest rates you would need to pay -banks sell mortgages to investment banks -as long as all mortgages are not put at the same time then risk will not happen -example the more money you lend out as a banker the more you get paid -in order to get more mortgages is to lend to risky borrowers -example banks of 100 000 they lend 1000 and then wait for borrowers to pay back in order to lend more money Subprime loans -prime loan (no credit history, and also stable job) -subprime (would be students) -higher risk and would be required to pay higher interest rates Adjustable rate mortgages -near the beginning you would need to pay low interest rate but over the years the interest rate would increase -this is because banks know that houses appreciate over time Leverage: using borrowed money to acquire asset Leverage = asset/assets – liabilities (excluding capital) =assets/capital Examples capital $3 Borrows $30 - Buys Assets for $33 Leverage = 11 (33/33-30) 33/3 = 11 Exam question 1. Assets increase in price by 10% Calculate return on equity Equity = $3 Borrows $30 Buys assets for $33 .........Asset 36.30 increase by 3.30 36.30-33/3 = 110 % 2. Assets fell in price by 10% Return on equity = -110% -from $33 to $29.70 Loss is 3.3 Current equity -0.3 -bank of Canada has negative net worth -as long as it meets its payments it will survive -extent of leverage (example hiding accounts from the balance sheet before the quarter and then adding it back after the quarter) Teaser interest rate: initial interest rate it appears
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