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QUESTION 3 C2 - Application of the concepts to a new context Read carefully the following article on Bear Stearns hedge funds collapse: 2021 sem 2 Text for C2 THA1.pdf In addition to the text we provide the following information. Bear Stearns was an investment bank in charge of managing hedge funds. Subprime mortgage backed securities are a form of ABS when the loans securitized are mortgage loans made to bad quality borrowers to buy houses. Using the information in the text and your own knowledge on hedge funds, answer the following questions: a) Draw a precise balance sheet of a Bear Stearns hedge fund. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (3 marks) b) Explain by which mechanism(s) borrowers defaulting on the interest and repayment of the principal of their mortgage loan affect Bear Stearns hedge funds unit investors. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (2 marks) c) Describe and explain the actions taken by the creditors/lenders to the Bear Stearns hedge funds. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (2 marks) d) Describe and explain the causes of the fire sales by Bear Stearns hedge funds. The text mentions one cause but overlooks a more obvious one. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (3 marks) e) Draw how the bailout of its hedge funds by Bear Stearns shows on the hedge fund balance sheet. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (2 marks) f) Find in the text some clue that short selling may have been involved. (1 mark) Hand write neatly the answers on a blank piece of paper with your full name and student number at the top of the page. Take a picture or several pictures if needed and convert it or them into a pdf file. Upload the pof file into this question. Only one pof file can be uploaded per question so merge your pictures if needed. Carefully keep your hand-written answers and your original pictures for future reference. Attach File Browse My ComputerDissecting the Beer Streams Hedge Fund Collapse By THE INVESTDPEDIA TEAM Updated April 2?, 2:121 Reviewed by ROBERT C. KELLY The headline-grabbing collapse of two Bear Stearns hedge funds in July seer offers a look into the world of hedge fund strategies and their associated risks. {. ._} we'll apply this knowledge to see what caused the implosion of two prominent Bear Stearns hedge funds the Bear Stearns High-Grade Structured Credit Fund and the Bear Steams High-Grade Structured Credit Enhanced Leveraged Fund. L. .1 Investment Structure The strategy employed by the Bear Stearns funds was actually quite simple and would be best classied as being a leveraged credit investment. In fact, it is formulaic in nature and is a common strategy in the hedge fund universe: 1. Step nu. 1Purchase collateralized debt obligations {CD-De] that pay an interest rate over and above the cost of borrowing. In this instance, AAA-rated tranche: of subprime mortgage-backed securities {MES} were used. 2. SteFr no. EUse leverage to buy more CID-[ls than you Inn pay for with equity Ilpital alone. Bee-use these CDDs pay an interest rate over and above the hedge fund cost of borrowing, every incremental unit of leverage adds to the total expected return. So, the more leverage you employ, the greater the expected return from the trade. 3. Step no. 3Use credit default swaps [DDS] as insurance against movements in the credit market. Because the use of leverage increases the portfolio's overall risk exposure, the next step is to purchase insurance on movements in credit markets. These \"insurance\" instruments are designed to prot during times when credit concems louse the bonds to fall in value, effectively hedging away some of the risks. 4. Steo no. 4Watch the money roll in. 1When you net out the cost of the leverage for debt} to purchase the 'AM' rated subprime debt, as well as the cost of the credit insurance, you are left with a positive rate of retum, which is often referred to as 'pcsitive lorry" in hedge fund lingo. r...r Can't Hedge All Risk However, the caveat is that it is impossible to hedge away all risks because it would drive returns too low. Therefore, the trick with this strategy is for markets to behave as expected and, ideally, to remain stable or improve. Unfortunately, as the problems with subprime debt began to unravel the market became anything but stable. To oversimplily the Elear Stearns situation, the subprime mortgage- backed security market behaved well outside of what the portfolio managers expected, which started a chain of events that imploded the fund. First lnlding of a Crisis To begin with, the subprime mortgage market by mid-EDD? had recently begun to see substantial increases in delinquencies from homeowners, which caused sharp decreases in the market values of these types of bonds [note of the lecturer". the subprime mortgage- backed securities]. Unfortunately, the Bear Steams portfolio managers failed to expect these sorts of price movements and, therefore, had insufficient credit insurance to protect against these losses. Because they had leveraged their positions substantially, the funds began to experience large losses. Problems Snowball The large losses made the creditors [Note of the lecturer: lender to the fund] who were nancing this leveraged investment strategy uneasy, as they had taken subprime, mortgage- backed boan as collateral on the loans. The lenders required Bear Steams to provide additional cash on their loans because the collateral [subprime bonds} was rapidly falling in value. This is the equivalent of a margin call for an individual investor with a brokerage account. Unfortunately, bee-use the funds had no cash on the sidelines, they needed to sell bonds [note of the lecturer". the subprime mortgage-backed sewrfties] in order to generate Inch, which was essentially the beginning of the end. Demise of the Funds Ultimately, it became public knowledge in the hedge fund community that Bear Steams was in trouble, and competing funds moved to drive the prices of subprime bonds lower to force Bear Stean'is' hand. Simply put, as prices on bonds fell, the fund experienced losses, which cause it to sell more bonds, which lowered the prices of the bonds, which caused them to sell more bondsit didn't take long before the funds had experienced a complete loss of capital. Bear Steams Collapse Timeline In earty 200?, the effects of subprime loans started to become apparent as subprime lenders and hcmebuilders were suffering under defaults and a severely weakening housing market. In June EMTFamid losses in its portfolio, the Bear Steams High-Grade Structured Credit Fund receives a $1.6 billion bait out from Bear Steams, which would help it to meet margin calls while it liquidated its posib'ons. o July '11", EMTIn a letter sent to investors, Bear Stearns Asset Management reported that its Bear Steams High-Grade Stmdured Credit Fund had lost more than 90% of its value, while the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund had lost virtually all of its investor capital. The larger Strudured Credit Fund had around $1 billion, while the Enhanced Leveraged Fund, which was less than a year old, had nearly $ million in investor capital. a July 31, EMTThe two funds led for Chapter 15 bankruptcy. Bear Steams effectively wound down the funds and liquidated all of its holdingsSeveral shareholder lawsuits have been led on the basis of Bear Steams misleading investors on the extent of its risky holdings o March 15. EHBJPMorgan Chase {JPM} announced that it would acquire Bear Steams in a stock-for-stock exchange that valued the hedge fund at $2 per share

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QUESTION 3 C2 - Application of the concepts to a new context Read carefully the following article on Bear Stearns hedge funds collapse: 2021 sem 2 Text for C2 THA1.pdf In addition to the text we provide the following information. Bear Stearns was an investment bank in charge of managing hedge funds. Subprime mortgage backed securities are a form of ABS when the loans securitized are mortgage loans made to bad quality borrowers to buy houses. Using the information in the text and your own knowledge on hedge funds, answer the following questions: a) Draw a precise balance sheet of a Bear Stearns hedge fund. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (3 marks) b) Explain by which mechanism(s) borrowers defaulting on the interest and repayment of the principal of their mortgage loan affect Bear Stearns hedge funds unit investors. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (2 marks) c) Describe and explain the actions taken by the creditors/lenders to the Bear Stearns hedge funds. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (2 marks) d) Describe and explain the causes of the fire sales by Bear Stearns hedge funds. The text mentions one cause but overlooks a more obvious one. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (3 marks) e) Draw how the bailout of its hedge funds by Bear Stearns shows on the hedge fund balance sheet. Quote the parts of the text that have allowed you to reach that conclusion and make explicit in your explanations any deductions you have made from what was written. Also mention when you have used your existing knowledge. (2 marks) f) Find in the text some clue that short selling may have been involved. (1 mark) Hand write neatly the answers on a blank piece of paper with your full name and student number at the top of the page. Take a picture or several pictures if needed and convert it or them into a pdf file. Upload the pof file into this question. Only one pof file can be uploaded per question so merge your pictures if needed. Carefully keep your hand-written answers and your original pictures for future reference. Attach File Browse My ComputerDissecting the Beer Streams Hedge Fund Collapse By THE INVESTDPEDIA TEAM Updated April 2?, 2:121 Reviewed by ROBERT C. KELLY The headline-grabbing collapse of two Bear Stearns hedge funds in July seer offers a look into the world of hedge fund strategies and their associated risks. {. ._} we'll apply this knowledge to see what caused the implosion of two prominent Bear Stearns hedge funds the Bear Stearns High-Grade Structured Credit Fund and the Bear Steams High-Grade Structured Credit Enhanced Leveraged Fund. L. .1 Investment Structure The strategy employed by the Bear Stearns funds was actually quite simple and would be best classied as being a leveraged credit investment. In fact, it is formulaic in nature and is a common strategy in the hedge fund universe: 1. Step nu. 1Purchase collateralized debt obligations {CD-De] that pay an interest rate over and above the cost of borrowing. In this instance, AAA-rated tranche: of subprime mortgage-backed securities {MES} were used. 2. SteFr no. EUse leverage to buy more CID-[ls than you Inn pay for with equity Ilpital alone. Bee-use these CDDs pay an interest rate over and above the hedge fund cost of borrowing, every incremental unit of leverage adds to the total expected return. So, the more leverage you employ, the greater the expected return from the trade. 3. Step no. 3Use credit default swaps [DDS] as insurance against movements in the credit market. Because the use of leverage increases the portfolio's overall risk exposure, the next step is to purchase insurance on movements in credit markets. These \"insurance\" instruments are designed to prot during times when credit concems louse the bonds to fall in value, effectively hedging away some of the risks. 4. Steo no. 4Watch the money roll in. 1When you net out the cost of the leverage for debt} to purchase the 'AM' rated subprime debt, as well as the cost of the credit insurance, you are left with a positive rate of retum, which is often referred to as 'pcsitive lorry" in hedge fund lingo. r...r Can't Hedge All Risk However, the caveat is that it is impossible to hedge away all risks because it would drive returns too low. Therefore, the trick with this strategy is for markets to behave as expected and, ideally, to remain stable or improve. Unfortunately, as the problems with subprime debt began to unravel the market became anything but stable. To oversimplily the Elear Stearns situation, the subprime mortgage- backed security market behaved well outside of what the portfolio managers expected, which started a chain of events that imploded the fund. First lnlding of a Crisis To begin with, the subprime mortgage market by mid-EDD? had recently begun to see substantial increases in delinquencies from homeowners, which caused sharp decreases in the market values of these types of bonds [note of the lecturer". the subprime mortgage- backed securities]. Unfortunately, the Bear Steams portfolio managers failed to expect these sorts of price movements and, therefore, had insufficient credit insurance to protect against these losses. Because they had leveraged their positions substantially, the funds began to experience large losses. Problems Snowball The large losses made the creditors [Note of the lecturer: lender to the fund] who were nancing this leveraged investment strategy uneasy, as they had taken subprime, mortgage- backed boan as collateral on the loans. The lenders required Bear Steams to provide additional cash on their loans because the collateral [subprime bonds} was rapidly falling in value. This is the equivalent of a margin call for an individual investor with a brokerage account. Unfortunately, bee-use the funds had no cash on the sidelines, they needed to sell bonds [note of the lecturer". the subprime mortgage-backed sewrfties] in order to generate Inch, which was essentially the beginning of the end. Demise of the Funds Ultimately, it became public knowledge in the hedge fund community that Bear Steams was in trouble, and competing funds moved to drive the prices of subprime bonds lower to force Bear Stean'is' hand. Simply put, as prices on bonds fell, the fund experienced losses, which cause it to sell more bonds, which lowered the prices of the bonds, which caused them to sell more bondsit didn't take long before the funds had experienced a complete loss of capital. Bear Steams Collapse Timeline In earty 200?, the effects of subprime loans started to become apparent as subprime lenders and hcmebuilders were suffering under defaults and a severely weakening housing market. In June EMTFamid losses in its portfolio, the Bear Steams High-Grade Structured Credit Fund receives a $1.6 billion bait out from Bear Steams, which would help it to meet margin calls while it liquidated its posib'ons. o July '11", EMTIn a letter sent to investors, Bear Stearns Asset Management reported that its Bear Steams High-Grade Stmdured Credit Fund had lost more than 90% of its value, while the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund had lost virtually all of its investor capital. The larger Strudured Credit Fund had around $1 billion, while the Enhanced Leveraged Fund, which was less than a year old, had nearly $ million in investor capital. a July 31, EMTThe two funds led for Chapter 15 bankruptcy. Bear Steams effectively wound down the funds and liquidated all of its holdingsSeveral shareholder lawsuits have been led on the basis of Bear Steams misleading investors on the extent of its risky holdings o March 15. EHBJPMorgan Chase {JPM} announced that it would acquire Bear Steams in a stock-for-stock exchange that valued the hedge fund at $2 per share

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