Quiz 1: Ch1

Name at least 4 major players in the financial market. In relation to capital, what typical roles do they play?

1) Firms: Demand Capital 2) Households: Supply Capital 3) Governments: Demand and Supply Capital 4) Financial Intermediaries: Facilitate Lending and Borrowing of Capital

After the 2008 crisis heavily involving Mortgage Backed Securities, what are the incentives for financial institutions to continue to own and trade these infamous securities?

1. Reduce risk by transferring the default risk to the buyer 2. Gives banks an opportunity to raise capital and continue lending money. Most institutions, and even more so after 2010 when the Dodd-Frank was passed, are heavily trained on the necessary steps to approve a borrower. Strict regulations on lenders and banks have been set in place since the debacle to prevent another recession (at least a recession caused by the same slip ups we saw in the 2008 housing bubble burst).

. What are the main four mechanisms used to mitigate Agency Problems?

1.) Compensate the managers of the firm based directly on its performance 2.) Let the elected Board of Directors monitor the activities of the managers 3.) Allow large investors and security analysts to monitor manager activities 4.) Takeover threat from other firms. This is more threatening to the managers of the firm being taken over because they are typically the first ones out of a job after the takeover occurs.

Who are the typical suppliers of capital?

Households are the typical suppliers of capital within the financial system, and this flow is facilitated by financial intermediaries. These institutions take in deposits and other funds and use them to fund business investments through loans and other financial products. However, some of these funds are also returned to households who take out mortgages and loans from financial intermediaries. It must also be noted that the textbook refers to the function of households as direct purchasers of firm securities within capital markets.

What are the differences between active and passive management?

Passive management does not directly search for undervalued/underpriced securities or time the market. Active management will do the opposite and search for the wrongly priced securities while timing the market.

Which management strategy agrees with the efficient market hypothesis and why?

Passive management strategy agree with efficient market hypothesis. Passive management strategy calls for holding a highly diversified portfolio without spending effort or other resources attempting to improve investment performance through security analysis. As efficient market hypothesis suggests that the market is accurately priced, therefore there is no arbitrage opportunities.

What is the difference between the primary and secondary market?

The primary market is where new and original securities are issued to the public. Securities can be sold only once in the primary market. The secondary market is where the securities are bought and sold among investors. Securities can be sold an infinite amount of times. Comment: Primary market is a market for newly issued securities, where as Secondary market is a market for investors who have previously issued.

Differentiate between asset allocation and security selection.

asset allocation refers to the choosing of broad asset classes such as stocks, bonds, real estate, commodities, etc. security selection refers to the choice in which particular securities are chosen to hold within each asset class.

Financial intermediaries services are in demand because which of the following? a. The financial intermediary only sells its own securities to the large investor. b. Small investors cannot efficiently gather information, diversify, and monitor portfolios. c. The financial intermediary works for non-profit. d. Their high success rate for returns on investments.

b. Small investors cannot efficiently gather information, diversify, and monitor portfolios.

All are derivative security except: a. interest rate swap b. cash flow backed security c. mortgage backed security d. options contracts

b. cash flow backed security

suppose the Government increases the minimum wage salary by 40% through the increase in taxes. looking back at the effects of systematic risk what effect does this has on a company who is affected by this risk?

there are several factors: 1) many investors won't have enough capital to buy stocks. 2) the company has to reduce prices on its products because the spending power of the general population will decrease. 3) investors who lost their jobs will sell their shares for quick cash.

How might a firm address agency problems?

-Manager compensation can be tied to success of firm by use of stock options. -BODs may force out underperforming management teams by use of proxy contests. -Underperforming firms may invite increasing scrutiny by security analysts & institutional investors who hold large positions in the firm stock. -Bad performers leave themselves vulnerable to being taken over by activist investors or hedge funds who believe they are being mismanaged in some way.

Define with examples for "Systematic Risk", "Systemic Risk" and "Idiosyncratic Risk". Also provide a possible cause of each risk. Is there a remedy or mitigation strategy for each risk?

-Systemic risk describes an event that can spark a major collapse in a specific industry or the broader economy. Systematic risk is the pervasive, far-reaching, perpetual market risk that reflects a variety of troubling factors. A common view of systemic risk is that the main cause is an outside event, for example a natural or man-made disaster likes a hurricane or the outbreak of war. -The opposite of idiosyncratic risk is a systematic risk, which refers to broader trends that impact the overall financial system or a very broad market. Systematic risk, also known as "undiversifiable risk," "volatility" or "market risk," affects the overall market, not just a particular stock or industry. This type of risk is both unpredictable and impossible to completely avoid. Systematic risk is that part of the total risk that is caused by factors beyond the control of a specific company, such as economic, political, and social factors. It can be captured by the sensitivity of a security's return with respect to market return. -Idiosyncratic Risk: Idiosyncratic risk refers to the inherent factors that can negatively impact individual securities or a very specific group of assets. Company management's decisions on financial policy, investment strategy, and operations are all idiosyncratic risks specific to a particular company and stock

Name the three (3) major players in the financial markets, and identify if they are a net source of capital, a net demander of capital, or both.

1) Firms, they are net demanders of capital (they raise capital in the present to pay for investments in PP&E, which generates the income to provide returns to their investors). 2) Households, they are net sources of capital (they purchase the securities issued by firms that need to raise funds). 3) The Government, they are both borrows are lenders (sources and demands), depending on taxes and government spending. (Since WW2 the government has spent more than it secured through taxes, making it a net demander of capital; during the brief periods of a surplus budget, the government has paid off some of its outstanding debt.)

There have been many instances in the past of management abusing their position for their own gain at the expense of the company's shareholders. List the three ways that the shareholders can mitigate this potential problem.

1) Tie a manager's compensation to the success of the company. 2) Force out management teams that are underperforming, ensuring the company runs smoothly. 3) Elect a different board by launching a proxy contest (where they try to obtain the most rights to vote from all shareholders).

Describe the four key mechanisms used to control the agency problem that exists due to the separation of management and ownership in publicly traded companies.

1. Compensation plans can be crafted in such a way that ties management's compensation to the performance of the stock price (example: stock options). If managers want to be richly compensated, they must manage in a way that increases the value of the firm. 2. The Board of Directors can force out underperforming managers and recruit better executives to manage the firm. 3. Industry observers such as securities analysts and institutional investors can put pressure on to perform better. 4. Poor performing management teams face the threat of takeover. In the absence of Board of Director action, shareholders can elect a new board. Often this is done by eliciting the proxies of other shareholders for the purpose of securing enough voting power to elect a new board of directors.

What does it mean when a firm is "too big to fail"? If a firm is too big to fail, is that good or bad for the firm?

A firm may be deemed "too big to fail" if it is so large in scale that if it failed, or went bankrupt, it will significantly affect the financial system. This is could be bad for the firm as it would be heavily regulated and forced to be more conservative in their financial decisions to prevent them from going bankrupt.

What type of investor would likely choose to invest in a firm's stock rather bond and why?

A more risk averse individual would choose to purchase a firm's bonds because bonds offer a fixed stream of income with less than risk than stocks. On the other a hand, a individual that is willing to take on some risk is more likely to purchase stock shares because they have the potential to reap greater benefits due to the additional risk that they are willing to bear.

Define what a portfolio is and describe the two types of decisions that are used when investors decide how to construct their portfolios.

A portfolio is a collection of investment assets. When deciding upon how to construct a portfolio, investors can utilize either a "top down" portfolio or a "bottom up" strategy. When utilizing a top down" strategy, the construction starts with asset allocation where a decision is made upon which broad asset classes will be utilized (i.e. stocks, bonds). Once asset allocations are determined, an investor will then utilize a security analysis to valuate the securities that will be held in each of the asset classes within the portfolio. The second type of decision that investors may utilize is the "bottom up" strategy. Within this strategy, investors construct their portfolio from securities based upon their prices, selecting the securities that have the more attractive investment opportunities.

Agency problems arise due to the conflicts of interest between managers and shareholders. List mechanisms that shareholders can leverage to decrease agency problems.

Agency problems can be combatted through 1) compensation plans that tie the income of managers to the success of the firm, 2) an effective board of directors, 3) pressure by security analysts and institutional investors, and 4) threat of takeover

Which of the following, from the text, are mechanisms designed to reduce agency problems? A. takeover threats B. nepotism C. management teams that are under performing being forced out by the board of directors D. unscheduled/scheduled audits E. stock or stock options as a form of compensation

Answer: A, C, & E

Which of the following explanations is correct? a. When an investor is taking a "Top Down" approach they look for companies that are performing at the top to invest in. While an investor taking a "Bottom-up" approach looks at how the market is performing, and decides which industry (or industries) they think will give them the highest return depending how the economy is doing. b. When an investor is taking a "Top Down" approach, they consider how the market is doing. For example if they think the market is going to grow, they might invest in assets in the tech industry which tends to outperform in growing economic periods. While an investor taking a "Bottom-up Strategy" might invest in a company they think will do well regardless of what the market is doing at the time. c. When an investor is taking a "Top Down" approach, they consider how the market is doing. For example if they think the market is going to grow, they might invest in a company that is outperforming everyone else. While an investor taking a "Bottom-up" Strategy might invest in an industry (or industries) they believe will do well regardless of how the market is doing at the time. d. In both strategies an investor can choose whether to invest in specific companies or overall industries. The main difference is when an investor is taking a "Top Down" approach they look at the market for guidance. While an investor taking a "Bottom-up" approach has their investments set up and leaves them alone regardless what the market is doing in the short term.

Answer: B is correct, because the main difference between the two approaches is "Top Down" looks to invest in industries depending on how the market is doing. They can invest in a bunch of industries or narrow it down to a couple. While "Bottom-up" looks at how certain companies are performing and how well they will do in the future, because the company they invest in might do well even if everyone else in that industry or economy is not.

Which of the following is NOT a financial intermediary? (A) Investment Companies (B) Banks (C) Insurance Companies (D) Government

Answer: D My explanation for this answer was pretty simple in that investment companies, banks, and insurance companies receive funds from their customers and disburse it for profit (While making sure they can pay back the original borrower). Government simply collects funds without an expectation of generating a greater profit or turning that money back over to the tax payer.

Before the big financial crisis in 2008, housing hit an all time high because of lower interest rates and a stable economy. Since housing was at such an increase, why did the decline happen so quickly?

Answer: The beginning of this change happened when agencies like Fannie Mae and Freddie Mac started buying mortgage loans and trading them. This is called securitization. Homeowners would pay for the loan to the originator and the originator would sell the mortgage to agencies in which the agencies would sell to the investors. This is one of the reasons why the housing prices began to decline in 2007 which sent financial markets into a panic. Also other firms hit bankruptcy and credit markets freezed. This all lead to the recession. (reference to Section 1.7)

What is the primary social function of financial intermediaries?

Answer: The primary social function of financial intermediaries is to channel household savings to the business sector.

What is the role and the impact of financial intermediaries in efficient markets?

By moving funds from parties with excess capital to parties needing funds, financial intermediaries create efficient markets.

What is the difference between Passive and Active Management? Which one is better?

Depends on what the client is trying to achieve. If they want to track an index then passive would be better and can be done at lost cost with ETFs. If the client wants to beat the market (have higher returns than the index), active management by highly skilled and trained professional who have access to more information would be better than your everyday trader. From the Powerpoint •Passive Management •Holding a highly diversified portfolio •No attempt to find undervalued securities •No attempt to time the market •Active Management •Finding mispriced securities •Timing the market

What is the agency problem with rating agencies and how could this be mitigated?

Financial companies (the principals) hire rating agencies (the agents) to provide ratings on the riskiness of their debt. Since a low rating from the agent would increase the cost of borrowing for the principal, it has an incentive to compensate the rating agency in a way that the agency will give them a higher rating then otherwise earned. The rating agency has an incentive to be less objective and give higher ratings so that they do not miss on our future business for being too critical in their ratings and therefore not hired on again. To mitigate this, the compensation for the rating agency can be tied to an objective measure different then the rating provided to the company. Also, the rating agency can be hired on autonomously from a third party company and therefore the company that brings them in to do the rating can be oblivious to which agency provided which rating.

what is the role of financial intermediaries and what is their relationship between small and large investors?

Financial intermediaries bring the suppliers of capital and demanders of capital together. Some of the financial intermediaries are bank, insurance companies, investment companies and credit union. For example, bank earns money by taking deposits and lending it to the other borrowers and the spread between rate paid to depositors and charged to lenders is bank profits. This way bank act as intermediary between lenders and depositors and lenders and depositors do not need to contact each other.

When considering the risk-return trade-off for markets and a investment is found that has a higher than expected return for the same or lower risk than other available investments, how does the market react?

Investors flock to the investment that has a higher than expected return than other investments without bearing additional risk. As more investors enter the investment the price is driven higher changing the attractiveness of the investment to less attractive.

What type of investment portfolio is sold in the retail market and is designed to attract a large number of clients?

Mutual Fund

Jane wants to improve her stock market performance. She attempts to identify stocks that she believes are mispriced and can earn a large return on. In a perfectly efficient market, is this a good strategy?

No. In a perfectly efficient market, it would be better to take a passive management approach vs. the active management approach Jane is taking. In efficient markets, the price reflects the value of the security, so a mispriced security would just be a low valued stock. A passive approach would diversify Jane's portfolio and use security analysis to attempt to improve the investment performance. (Section 1.5) comment: Security analysis would be in involved in an active management strategy.

Should an investor only rely on stock prices to judge a firm's current performance?

Not necessarily, while a firm's stock prices are normally a pretty accurate representation of its performance, they can also be misleading. In general, a stock price is a good indication of the assessment of a firm's current performance and future performance. As a firm grows and excels, its share price will raise and attract more investors. The problem that can arise is that a firm can attract a lot of investors and seem to be performing well but then fail horribly. A good example of this is the dot-com bubble. While stock prices are normally a reliable accurate representation of a firms success, it is important to be aware that they are not infallible.

Identify three reasons to use passive investing and three reasons to use active investing. Briefly discuss the main reason behind the historic shift to index funds.

Passive Investing (Ex. Index Funds) 1. You want to keep your transaction costs as low as possible 2. You have a long-term time horizon 3. You are concerned about taxes Active Investing (Buying and Selling specific investments such as AAPL stock) 1. You are willing to pay more for potentially higher returns 2. You have a specific investment objective (income vs growth) 3. You have a shorter time horizon and may need to withdraw in a downturn In August 2019, for the first time ever, the average investor is classified as a passive investor. Index funds totaled $4.271 trillion while stock pickers totaled $4.246 trillion. The driving force behind the change is fees. Active funds fees are 7 times higher than index funds.

What is the difference between passive and active management strategies, and which strategy would theoretically be more effective assuming markets are efficient and prices reflect all relevant information?

Passive management strategies call for holding highly-diversified portfolios without spending effort or other resources to improve performance through security analysis. In contrast, active management strategies attempt to improve performance through identifying mispriced securities or timing the performance of broad asset classes. Assuming an efficient market where prices reflect all relevant information, passive strategies would be more effective than active strategies since active strategies would cost additional resources and time for no new information.

Many changes in the housing market and risky behaviors from major financial institutions lead to the Financial Crisis of 2008, the "Great Recession." Specify and briefly describe three catalysts or causes of the financial crisis.

Potential Answers (not a complete list): Banks originated mortgages to distribute instead of to hold as they would have previously. Banks could essentially pass on the risk of lending to purchasing institutions while collecting a servicing fee from the borrower. Due to the ability to originate, package, and sell mortgages for securitization, banks began to originate mortgages indiscriminately to all borrowers, even those with little to no credit (sub-prime or non-conforming) since they knew they would not have to shoulder the risk of default. Banks could essentially pass on the risk to purchasing institutions while collecting a servicing fee from the borrower, so the market became saturated with low-quality mortgages. Larger institutions then securitized bundles of mortgages to allow investors to invest in the housing market. The proliferation of MBS and CDOs helped the rise in popularity of the Credit Default Swap. The CDS was an instrument that acted as an insurance contract to the investor wherein the investor could pay a small premium to an institution to guarantee a payout on the MBS/CDO in the even of default. Because these securities were erroneously considered such low-risk, institutions like AIG sold billions in CDS contracts, sure that the underlying securities would not default. As default rates skyrocketed, systemically important institutions lost the ability to payout on the CDS contracts they had sold and were bankrupted by the crash of the housing market. One of the main causes of the rise in default rates was a specific type of mortgage - the Adjustable Rate Mortgage, or ARM. ARMs allowed borrowers to originate their mortgages at very low advertised "teaser rates" designed to incentivize borrowing for those who normally would not be able to afford a mortgage. After a certain period of time, the teaser rate would expire and the floating rate on the mortgage would reset to market rates, which were much higher. Borrowers were suddenly able to pay the interest on their mortgages and walked away from the loans, thus causing unheard of default rates. The risk of CDOs and MBSs on the market was significantly underestimated by ratings agencies. The institutions selling these securities had to pay fees to rating agencies like Moody's or Standard & Poor's for them to grade the securities and place them on the market. In order to secure fee revenues, rating agencies promised grades which did not reflect the true riskiness of the underlying mortgages in the securities. Securities that were composed of mortgages with high default risk were rated as investment grade when they truly should have been rated lower.

What is security analysis and it what ways does it tie into the Efficient Markets Hypothesis (EMH) ?

Security analysis is the act of doing research into specific securities in an attempt to find their true intrinsic value. It is done to perhaps obtain a benefit from securities which market prices do not fully reflect their real value. According to the efficient market hypothesis all market prices are fully reflective of all information, both private and public , related to each individual security. Therefore according to this theory security analysis is irrelevant and investors are better off being passive. However, one can argue that without security analysis securities prices would not fully reflect all information, therefore making their prices inaccurate.

What is the difference between systematic risk and unsystematic risk?

Systematic risk is any risk that is inherent within the stock market, while the unsystematic risk is the risk to a firm or industry. The biggest difference, however, is that you can eliminate unsystematic risk by diversifying your portfolio.

What is the difference between top down and bottom up portfolio management?

TD portfolio construction starts with an asset allocation dependent on appetite for risk and subsequent investment decisions of specific securities are only made thereafter. BU portfolio management focuses on securities that appear to offer the most attractive returns but can result in unintended portfolio concentrations of one or another sector. Course textbook, pg 9

Explain the differences between "top-down" and "bottom-up" methodologies as it pertains to portfolio construction.

The "top-down" approach to portfolio construction will first determine the amounts that an investor should allocate to broad asset categories. This can be as basic as percentages to be allocated to stocks, bonds and cash or become more granular within an asset category such as U.S. stocks vs. International stocks vs. Emerging Markets stocks. Taking this a step further, the asset allocation could be further deduced within these equity categories, for example, into U.S. Large-cap Value and Growth, U.S. Mid-cap Value and Growth, as well as U.S. Small-Cap Value and Growth. The goal of a well-diversified portfolio constructed of many asset classes (that are not perfectly correlated) is to reduce risk to the portfolio over time. Depending on a portfolio's exposure to these various asset classes, assumptions/projections can be made that help shape expectations for volatility over time. A top-down investor will make asset allocation decisions before turning to specific security analysis. A "bottom-up" investor will construct their portfolio based on the relative attractiveness and value of each security without regard for the resultant asset allocation. If each security is analyzed with an eye toward being undervalued, this can lead to inadvertent over-exposure to a particular industry, business or product line that may leave the investor at risk if that particular area/industry underperforms. Of course, this can be mitigated by looking for relative value within each asset class.

In response to the 2008 financial crisis, what piece of legislation was passed to increase transparency and provide stricter rules in the financial industry?

The Dodd-Frank Reform Act

What reform was passed to prevent another systemic risk event like the 2008 housing crisis and what did it do?

The Dodd-Frank Reform Act: it increased regulations on banks capital, liquidity and risk management systems as well as increasing transparency on derivitves.

What part of the Dodd-Frank Wall Street Reform and Consumer Protection Act was created after the 2008 financial crisis to limit banks ability to trade on their own accounts? What did this legislation replace that had been repealed in 1999?

The Volcker Rule limits how much banks can trade on their own accounts and is a replacement of the more restrictive Glass-Steagall Act which separated commercial and investment banking in the United States. p14 Words from the street

What is the agency problem and what potential impacts can it have on firm performance? What kind of issues can occur when the chief executive officer is also chairman of the board of directors?

The agency problem occurs due to the inherent conflict of interest in any agent/principal relationship. In this case the managers are the agent, and are expected to act in the best interests of the principal. The firm's shareholders are the principal, and expect management to sacrifice their own self-interests in exchange for maximizing shareholder wealth. The agency problem manifests itself due to management being expected to always act in the best interests of the shareholders; this does not always occur since they may choose to pursue their own self-interests and maximize their own wealth, foregoing the needs of the shareholders. The agency problem can negatively impact firm performance due to managers sacrificing long term growth/investment opportunities in return for an increase in short term performance. For example: stock price may be directly tied to management compensation incentives, and managers may go so far as inflating their firm's stock price short-term to receive compensation while selling their own stake in the company while the price is artificially high, even if it means the firm's performance suffers when the true value of the stock is revealed, i.e. Enron. A conflict of interest occurs when the CEO is also chairman of the board due to this individual being able to simultaneously direct board meetings and willingly act in their own self-interest, which otherwise may not occur when there is a chairman separate from the firm's management to represent the shareholders. This helps to ensure that management objectives are aligned with maximizing shareholder wealth. The concept of CEO duality weakens board oversight and the system of checks and balances that have been put in place to protect the interest of a firm's shareholders.

The agency problem represents a mismatch of interests between the managers of a company and its shareholders. Managers have an incentive to take big risks for big profit, while stockholders want maximized stock prices and minimal risk exposure. What is one way that this can be remedied? Pegging bonuses with stock options, thus giving managers an incentive to do well Using options to manipulate info to boost up a stock price Hiring a Board of Director to oversee managerial decisions Immediate firing of executives when there is underperformance

The correct answer is A. Using options to manipulate only worsens the agency problem. The Board of Directors oversees the hiring and firing of executives, NOT the managerial decisions. Finally, the Board doesn't immediately fire when there is underperformance, however if it repeats then the Board will vote executives out.

What role did the credit rating agencies play in the financial crisis? (See page 19-20 for answer).

The credit rating agencies played a substantial role in the eventual financial crisis a number of different ways. The biggest was easily the extremely underestimated risk in securitized assets. Securitized assets are illiquid assets, such as car loans or mortgages, that are pooled together and through financial engineering are transformed into a security which is then given a credit rating from a credit agency. The main problem here was that ratings agencies were paid by the issuer, not the purchaser, for the ratings of these assets. Due to this, issuers would shop around until they got the rating that they wanted. This pressured rating agencies into giving better ratings than these asset truly deserved which ultimately led investors (purchasers of these assets) to think they were investing in a high grade low risk asset, when in reality they were investing in junk assets. This along with relaxed loan requirements ultimately led to the financial crisis we saw back in 2008.

What is the difference between the primary and secondary market?

The primary market is where Investment Bankers market the original issuance of securities to the public. The secondary market is where the securities are bought and sold among investors. Most people trade on the secondary markets.

Who are angel investors?

These are people who have capital available to invest in a start-up company in return for higher rate of return than traditional investment.

What is the difference between" top down" and "bottom up" portfolio construction?

Top down portfolio construction refers to the process of creating a portfolio by first selecting the asset allocation and their prorata share of the overall portfolio (i.e., % of stocks, bonds, etc. that will make up the portfolio) and is followed by the selection of individual securities within each asset classification. Conversely, bottom up portfolio construction refers to the process by which individual securities are selected first based on an analysis of their market price and less weight is given to the overall asset allocation, potentially resulting in high concentrations of asset classes.

Regarding the financial crisis of 2008, what is the term for prioritizing claims on loan repayments by dividing the pool of loans into senior and junior slices, with the senior slices being paid first.

Tranches

What were some of the problems with derivatives, specifically with regard to the 2008 financial crisis?

While derivatives are useful for hedging and for speculating, they are very complex and being able to understand them and their underlying assets is critical for their success. Banks started pooling their mortgages into securities backed by their underlying mortgages into Mortgage Backed Securities (MBS) through a process called securitization. This allowed a creditor to take a pool of mortgages that would individually be rated B or lower into a security whose cash flows are rated AAA. This created multiple issues though as we will soon see. The first issue was involving the banks and their obligations for due diligence. Since these banks could easily sell the loans off and pass the risk to someone else, they had very little incentive to properly screen and assess the credit risks for the individual mortgages, especially subprime mortgages. As a result, these securities would be rated AAA/A+ even though the mortgages were junk grade or lower. The securities were overvalued and when defaults on mortgages began they lost massive value creating huge losses for investors and banks. The second main issue was regarding investors. Since most investors did not understand the true nature of these derivative securities they didnt understand the level of risk they were taking. They see the A rating and assume that it is a safe secure investment but had they taken the time to udnerstand the derivatives these investors could have protected themselves better. These factors, along with the housing market crash, led to the financial disaster of 2008. As a result, derivatives have become heavily regulated and require banks to state risk levels on and off balance sheet.