(3 points) What are the three most important ways the financial industry changed in the two decades leading up to the financial crisis?

1) The ethics of wall-street changed after they repealed the glass-steagall act.2) Clients were now viewed as counter parties so that firms did not share expertise, knowledge and judgment with clients. Rather they were to be duped and kept in relative ignorance.3)

(2 points) What role did compensation practices play in the financial crisis? What role can they play in Wall Street Ethics in the future?

(5 points) Compare and contrast the purposes the Glass-Steagall Act and the Volcker Rule and the impact they each have on the financial industry.1) Glass Steagall Act Prohibited commercial banks from participating in the investment banking business.2) Volcker Rule Prohibits banks from proprietary trading. Restricts investment in hedge funds and private equity by commercial banks and their affiliates.3) Proprietary Trading occurs when a firm trades stocks, bonds, currencies, commodities, their derivatives, or other financial instruments with the firms own money as opposed to depositors money, so as to make a profit for itself.4) Glass Steagall act helped to deregulate the financial industry, as a result many commercial banks started to go into the investment banking business as well and vice versa. This deregulation allowed commercial banks to make dangerous bets which eventually result in the financial crisis in 2008. It also created a conflict of interest between a banks interest and those of its customers via proprietary trading. The Volcker Rule aims to fix this by saying that firms cannot do proprietary trading. (5 points) What is VaR? Give an example of how it might be applied to a traders portfolio. How would you compare the way Goldman Sachs handled VaR in the first half of 2007 with the way JPMorgan Chase handled it during the London Whale Trades?1) Value at Risk is a measurement created by JP Morgan to measure the risk of the increasingly large and volatile portfolios. It is a measurement that estimates the loss a given portfolio could experience based on historical data. For example, one might use the average of the worst 33 days in the previous years performance to estimate how much a portfolio might decline the following day.2) GS handled VaR with a lot more caution than JP Morgan. In 2006 GS shorts were making a lot of money so GSs clients were asking for more. But GS didnt give it because even though GS realized it could make much more money, GS held back on making even more risky investments and just settled with the profit it already had. GS did not succumb to greed. 3) JP Morgan however ignored all the danger signs that the VaR for its portfolio was giving. They even created a new VaR in a hurry to try and lower its already dangerously high VaR for the enormous trades that they were making with their own money. As a result they lost a lot of money and is now famously known as the London Whale Trade. The fact that JP Morgan chose to ignore all the flashing red lights from VaR showed that it had a lack of restraint and good management. They only had eyes on the money they could have made and not the losses they could have sustained.(3 points) What is the Volcker Rule? What are the two most important exemptions to the rule?1) Value at Risk is a measurement created by JP Morgan to measure the risk of the increasingly large and volatile portfolios. It is a measurement that estimates the loss a given portfolio could experience based on historical data. For example, one might use the average of the worst 33 days in the previous years performance to estimate how much a portfolio might decline the following day.2) Market Making - The Ability of banks to trade on behalf of clients or eventual clients; the way they make the bulk of their trading profits and thus create risk.3) Underwriting The creation of securities that can contain multiple layers of financial complex. (underwriter the people who create Collateralized Debt Obligations)4) Hedging - An investment to reduce the risk of movements in an asset.(i.e. futures contract)

(3 points) What are derivative securities? What role did they play in the financial crisis?1) Derivative Securities A security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates, and market indexes. Most derivatives are characterized by high leverage.2) They played a role in the financial crisis because many banks over valued mortgage-backed securities and made derivatives based on this incorrect knowledge. They thought that the value of MBS would go up. That is why when Lehman Brothers went bankrupt and banks suddenly realized that they made the bet on the wrong side, they had to pay up, yet they didnt have any money to do that. So they had to declare bankruptcy and many people who invested in/with these companies lost a lot of money. Banks also stopped lending to people because they didnt have money to pay back their debts so they couldnt lend money.

(2 points) What is the difference between a Certified Financial Advisor and a Broker-Dealer? What advantages does each offer?1) Broker Dealer: is a person or company that is in the business of buying and selling securities(stocks, bonds, mutual funds, and certain other investment products) on behalf of its customers (as a broker), for its own account (as dealer), or both.2)

(5 points) What is the relationship of the financial industry to free markets? What happened to this relationship during the financial crisis?1) Because banks involved in proprietary trading were more interested in their own profits to

(5 points) Describe the Abacus transaction. Who were the parties to the transaction and what were they each thinking? Who put the deal together? What was the most unethical aspect of Abacus.1) According to the SEC 83% of the Abacus portfolio had been downgraded by Oct. 24th 2007 and 17% was on negative watch. By Jan. 29th 2008, 99% of the portfolio had been downgraded. Investors in Abacus CDOs lost more than $1 billion.2) Goldman also failed to disclose Paulson & Co.s role to the credit rating agency that assigned AAA ratings to the two tranches of Abacus securities.3) Biggest question is why Goldman would trade the firms decades in the making reputation for integrity and honest dealing for a mere $15 million in fees.4) Goldman sold the CDOs in Abacus after forming a strong firm-wide judgment that the CDO market was in serious trouble. And while the firm was investing its own capital against the advice it was giving to clients.People1) GS Put the deal together. Was the agent for both Paulson & Co. and IKB. Goldman was also acting as a principal on its own behalf when it bought the ABACUS CDO and put the deal into its own books.2) Paulson and Co. Provided lots of input to ACA for which collaterals were used in the CDOs. Helped to structure a CDO that is filled with the worst possible subprime mortgages to increase the instruments chances of failure. a. Shorted ABACUS by entering into credit default swaps to buy protection on specific layers of the CDO (specifically the senior tranches)b. Its motive was to sell the CDO it made to investors so that Paulson & Co. had a financial instrument in the market against which it can bet.3) ACA Management Hired by GS to pick the collateral for the CDO and also to give the CDO credibility. They were hired for marketing purposes. It was a well-known manager of CDOs.4) IKB - Bank that bought ABACUS5) SEC Alleged that Goldman made materially misleading statements and omissions in connection with the ABACUS CDO placement. The SEC charged that Goldmans marketing materials for ABACUS conveyed that ACA Management, an independent 3rd party with experience analyzing RMBS credit risk, selected the reference portfolio of the RMBS underlying the CDO. In fact John Paulson (who, unbeknownst to IKB, had a direct adverse economic interest in the instrument) played a significant role in the portfolio. Instruments1) RMBS(Residential Mortgage-Backed Securities)2) Synthetic CDOs3) Credit Default Swaps (CDS)

1) Conflicts of Interesta. GS was serving both Paulson & Co. and IKBb. It appears in the Abacus case Goldman favored Paulson & Co. Over IKB because GS followed the instructions of Paulson closely but seemed to be less concerned about fulfilling its fiduciary duty to IKB.