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Inside_Job_-_Qestions.docx

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Department
Economics
Course
ECON 331
Professor
All Professors
Semester
Fall

Description
Assignment based on the movie Inside JobCaution This assignment will be graded and will carry twice as much weight as a single quiz ie this is worth two quizzesDeadline to submit is December 3 Mon 1145 pm I cannot and shall not accept a late submissionSubmit your answers using the link called Submit Inside Job assignment here Due Dec3 Worth 2 quizzes on MoodleBackgroundAlthough the basic function of financial markets is straightforwardto match people who have money with people who need moneythe way finance and Wall Street actually operate can get very complicated and involves lot of jargons The movie Inside Job however does not involve very many new terms and explains the recent global financial crisis nicely even though some of the opinions in the movie may seem biasedThe terms Residential Mortgage Backed Securities RMBS and Collaterilized Debt Obligations CDO under chapter 9 Please review those slidesare explained in the file Subprime Mortgage Market and the Great Recession available on your Moodle course page The term Credit default swap CDS is nicely explained in the movie Inside Job itself The textbook chapters 13 and 14 also explains them in detail However you do NOT have to study chapters 13 and 14 before watching the movieHistorically banks that loaned money to home buyers kept those loans and bore the risk of default Thus banks had an incentive to make sure borrowers repaid them This is one reason why banks required a downpayment It also is why they charged subprime borrowers higher rates Over time banks began bundling mortgage loans together into pools known as residential mortgage backed securities RMBS Large institutional investors such as pension funds bought these RMBS Because the RMBS included a diverse pool of mortgage loans they were deemed to be safe investments The credit rating agencies gave these RMBS their highest ratings of AAA Now investorsnot the lending banksbore the risk of default Next banks began bundling these RMBS together in a second kind of pool known as collateralized debt obligations CDO The banks and rating agencies used complex computer models to determine what portion of a CDO could be labeled AAA The rating agencies then gave AAA ratings to large portions of CDOs even though the mortgage loans backing the CDOs were subprime The fundamental reason behind giving these CDOs AAA ranking was the expectation that real estate prices would not decrease and not all subprime borrowers can fail at the same timeSubprimebacked CDOs were popular because they had high credit ratings and paid high returns The credit default swap CDS was a tool to enable banks and investors to bet on subprime RMBS and CDOs
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