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Question 12: Essay Question

a. Use intuitive words to explain what are credit default obligations (CDOs) and credit default swaps (CDSs).

b. Describe the financial crisis in 2008. When describing, you need to explain subprime mortgages and mortgage backed securities (MBS) and why they could thrive for more than a decade. Depict the roles of home buyers, mortgage bankers, MBS investors, investment banks, insurance companies, credit rating agencies, etc.

c. Finally, explain why derivatives such as CDOs and CDSs had such a destructive power that results in a total financial market meltdown, not only in United States, but worldwide.

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Trinidad Tremblay
Trinidad TremblayLv2
28 Sep 2019

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Question 12: Essay Question

b. Describe the financial crisis in 2008. When describing, you need to explain subprime mortgages and mortgage backed securities (MBS) and why they could thrive for more than a decade. Depict the roles of home buyers, mortgage bankers, MBS investors, investment banks, insurance companies, credit rating agencies, etc.

c. Finally, explain why derivatives such as CDOs and CDSs had such a destructive power that results in a total financial market meltdown, not only in United States, but worldwide.

Staying Alive in Tough Economic Times

Going broke is an idea that any business hates to think about. However, if you are going to go broke in the United States, it helps to be a large, established company. For example, after the September 11, 2001, terrorist attacks, the government stepped in and saved major air carriers like American and United. More recently quasi-government agencies like Fannie Mae and Freddie Mac received money from the government to stay afloat despite poor practices in the mortgage business. Banks that risked capital on risky investments like derivatives and credit swaps were also beneficiaries of the federal government’s largesse. Even automakers whose managers misjudged the market were propped up by government dollars. Which leads us to the question, “What if small-business owners run out of cash?”

The simple answer is, it’s goodbye to the business. That’s why having enough cash on hand (liquidity) is especially critical for entrepreneurs during economic tough times. Unfortunately, this is no simple task. Liquidity for small companies can change almost immediately due to some unexpected event such as a major customer going out of business or perhaps an unexpected natural catastrophe like a flood. Experts agree that keeping enough liquid assets (like cash and cash equivalents like bonds) to fund the next six months is a good rule of thumb. If you keep a reserve of liquid assets, you have time to work on a remedy if a crisis hits rather than having to close your doors.

Accountants and financial managers also advise small businesses to be particularly aware of three ratios to make sure the business is liquid enough to survive: current ratio, quick ratio, and the debt-to-equity ratio.

Current ratio: current assets divided by current liabilities. Most bankers like the ratio to be at least 2:1.

Quick ratio: cash and receivables divided by current liabilities. This ratio addresses the scary question of whether or not a company can meet its obligations if sales suddenly fall or dry up. A ratio greater than 1:1 is often acceptable.

Debt-to-equity ratio: total liabilities divided by shareholders equity. The higher this ratio is the less likely bankers can deal with you. A ratio below 3:1 is often considered safe for small businesses.

Locating corporate annual reports is easier than it has ever been. AnnualReports.com (Links to an external site.)Links to an external site. hosts a website (www.annualreports.com/ (Links to an external site.)Links to an external site.)[i] containing annual reports for hundreds of corporations. The site is comprehensive and easy to use. You can also find publicly traded companies Annual Report on their websites, usually under "Investor Information".

Go to the website (www.annualreports.com/ (Links to an external site.)Links to an external site. ) and choose one company to research. Use the information given in this report to answer the following questions. (Sometimes the Web address for a location changes. You might need to search to find the exact location mentioned.)

1. What is the name of the company?

2. What is the financial year?

3. Calculate the three financial ratios discussed above and listed below and the additional calculations below. Show your work for the ratios. Provide a link to the Annual Report or source you used for the financial information.

a. What is the current ratio?

b. What is the quick ratio?

c. What is the debt-to-equity ratio?

d. On their Balance Sheet, find their Total Assets. What is the total?

e. On their Balance Sheet, find their Total Liabilities. What is the total?

f. On their Income Statement, find their Total Revenues. What is the total?

g. On their Income Statement, find their Total Income. What is the total?

4. Reflect on these calculations. What do they tell you?

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