0:11 mortgage. So I hear houses
0:12 which is also linked to mortgage for sure.
0:18 Yeah, remember you have to be read about
0:20 strategy papers. You have to be in the
0:22 news. You have to know what is going on.
0:23 You have to know a bit of history in the
0:26 financial market as well. Yeah, like I
0:28 told you, you're going to be doing a lot
0:29 of analysis, especially in a paper like
0:32 this. It's not a paper where you just
0:34 memorize concept and think you're fine.
0:37 No, never. You have to have a good
0:39 understanding of the economy and be able
0:42 to make sensible, intelligent
0:43 intelligent
0:45 conversation in your reports because
0:47 most of your marks you will get from
0:50 writing reports, not from calculation.
0:52 So you being able to link calculations
0:55 to the reality and to
0:57 things you have based on your experience
1:00 is very critical.
1:02 You're right
1:04 mostly coming from mortgage but from
1:06 other also credit products and that's
1:11 why this 2008 we was timed like a credit
1:14 crunch period.
1:17 If you heard about credit crunch,
1:20 that was 2008. Credit crunch, that was
1:24 what we saw in 2008. And what happened?
1:26 A lot of banks were carrying a lot of
1:28 toxic assets
1:31 in their books.
1:34 Toxic assets. And toxic assets is not
1:37 like it's poisonous to people, but to
1:39 the company. That's why it was termed
1:42 tox toxic asset. And it toxic. It's it's
1:45 toxic because they have assets that they
1:47 thought would be recoverable. However,
1:49 However,
1:52 they were not recoverable. Yeah. Not
1:54 just mortgage but loans generally. What
1:57 do they do?
2:01 Banks were giving out loans.
2:04 So let me try and explain this way. So
2:17 let's say
2:20 500 million
2:24 but bank needs cash but they've given
2:26 cash to customer A customer A probably
2:28 needs to pay this back over 10 years for example
2:30 example
2:33 but rather than them waiting for
2:36 customer A to pay back bank decides to
2:40 establish lish a special purpose vehicle
2:44 and what do they do? They sell this loan
2:47 to this SPV
2:50 and what would SPV do to the bank
2:53 because they've sold Yeah,
2:56 you've sold to SPV. SPV would now need
2:59 to give cash to this bank.
3:01 So, which means in the books of this
3:04 bank, they look good because they got cash.
3:06 cash.
3:09 canceled out the receivable that they
3:11 have from customer A. So which means
3:15 this SPV is now the one that is
3:19 looking forward to receiving money from
3:23 customer A. But rather for this SPV to
3:25 wait to receive the money, guess what
3:27 SPV does again? The SPB will now start selling
3:29 selling
3:32 this pieces to investors. So you have
3:35 investors A,
3:39 B, C, D, E. So this 500 million is now
3:41 being sold to this guy in different
3:44 tanches. Maybe this guy took 100
3:47 million. Maybe this guy 200, maybe this
3:49 guy 50,
3:53 this one another 100. No like that. So
3:56 in tanches such that this investor A B
3:59 CDE E they were offered each of these
4:01 tanches at different rates depending on
4:02 how they have grouped it. So these
4:04 experts are also they were very very
4:09 very intelligent. They they ran this in
4:11 different levels. So you know that you
4:13 are kind of in risk as much as you you
4:15 want to. If you want your money to be
4:18 guaranteed your rate might be lower. So
4:21 take for instance if this 100 is given
4:24 at 5% to investment A and they say okay
4:27 this is investment grade bond that's
4:28 what they will call it then they say
4:32 okay this is less more risky which means
4:34 it's less secured then they might
4:37 increase the rate to 7%.
4:38 By the time it gets to this one they
4:40 might say this one is subordinate so
4:43 you'll be able to get 10% on it. However
4:45 just know that upon liquidation you are
4:46 not sure you'll be able to get your
4:49 capital back. So all these investors A B
4:54 CDE E they've bought into this SPV this
4:57 so-called 500 million. So this 500 could
4:59 have been mortgage most in the US most
5:02 of them were mortgages.
5:05 So bank were just giving mortgage out as
5:07 they like to because once they give them
5:09 out they repackage them into SPVS sell
5:12 them out as what you call CDO. Yeah,
5:16 that's that was popular then CDO or you
5:18 call the collaterized
5:31 CO. So they were just selling those CDs
5:35 just like you selling bonds to different
5:38 people. And guess what? The problem
5:43 started when a lot of these products
5:45 were being sold out to people because
5:47 banks were not even doing their due
5:48 diligence way they should be doing it.
5:52 So at the point they started selling to
5:55 anybody and some of these customer were
5:58 not able to repay back their loan. So
6:00 the chain started failing at the point
6:02 where this customer will not be able to
6:06 pay back because they just the were so
6:11 many that they've sold a lot of bad
6:14 bad loans to customers and when
6:16 customers are not able to pay what
6:19 happens the final investors will not be
6:20 able to get their money back because
6:22 these guys bought the bonds that they'll
6:26 be thinking will definitely mature in
6:27 the future and they will get their money
6:30 back. So these bonds were maturing and
6:33 the SPV is not able to pay back as SP is
6:35 not able to pay back. There's a problem
6:37 because the SP is supposed to be able to
6:40 pay back from the money that customer A
6:41 is paying back because the bank has
6:43 already collected the cash from SPV. So
6:45 the SP is supposed to be chasing this
6:47 customer to get this cash back such that
6:49 once they get the cash back they can
6:52 settle the investors upon the majority
6:54 of the investment and that was when
6:57 everything started collapsing.
7:00 The big companies were dying and a lot
7:02 of companies have to merge. A lot of
7:05 companies were liquidated and what
7:09 happens investors lost a lot of money
7:10 and that was the credit crunch that we
7:14 had in 2008. Yeah. So the international
7:16 market that is trying to achieve
7:18 transparency, achieve flow of funds at
7:20 the same time might get to a point
7:23 whereby those situations were being
7:26 taken advantage of by investors either
7:30 deliberately or inadventedly. But
7:33 regardless the case, it still boils down
7:36 to the fact that you as an executive,
7:38 remember you're an executive and
7:41 advisor, you need to understand how
7:44 these integrations work and how a
7:47 company can actually benefit
7:49 so far from
7:52 regulations, from transparencies, or
7:55 from even trying to take advantage of
7:59 another economy in a different country.
8:02 extremely important. Yeah. Well, let
8:03 just because this I mean these are
8:05 typical things you can see short
8:07 questions that you can be part just to
8:09 test your understanding.
8:13 Yeah. On CDO because
8:15 you need to get the concept right. What
8:17 I just explained I'll put in a
8:19 calculation for you and let's work it
8:22 out together.
8:27 So let's say we have bank B.
8:29 I need you all to try this.
8:40 loan to customers of total of 500 million.
8:46 Yeah.
8:49 At 9%.
8:51 So this bank has given out loans to
8:54 customer at 9%. So remember my scenario.
8:57 So like this guy, this 500 million is at
9:00 9%. That's what we're saying. Now
9:02 Now
9:04 they don't want to do CDOS,
9:07 collateralized debt applications. Yeah.
9:10 And they trying to do it with just the 95%
9:12 95%
9:15 of the loan.
9:16 That's what they want to trade. They
9:19 want to trade 95% of this 500 million.
9:22 So which means that they they will be
9:30 of 500 million
9:33 and what will that be? Uh.95
9:35 Uh.95 times
9:36 times >> 475.
9:38 >> 475.
9:43 >> Yeah 75 million. So 75 million is what
9:53 want to sell that. Now
9:54 Now
9:56 remember the way it's been sold, it's
9:59 been sold in trenches, different ranking
10:01 and the ranking will affect the interest
10:03 rate as well because remember in FM you
10:05 learned that the higher the risk, the
10:07 higher the reward. So let's say they
10:09 want to set tranch one, tranch two and
10:13 tranch 3. TR one will be 70% of that.
10:16 Trans two will be 20%.
10:23 So for TR one
10:27 he said is a rated which means they are
10:29 protecting it secured and they ready to
10:32 give it at 7% to whoever wants to buy.
10:35 That's how the SP is selling it. The
10:38 other TRS which is TR two they are
10:40 saying is B rated.
10:45 So which means not as sure as this one
10:47 that you get your money back but you get
10:49 more interest because you are taking 10%.
10:51 10%.
11:08 and the question is what is the maximum
11:12 rate do you think this bank
11:26 what rates what rate do you think they should
11:28 should
11:30 what rate do you think they should be
11:32 given to the customers that are
11:36 subscribing to the C-rated CDOS
11:39 like I said it's not there's no it's not
11:43 it's more just working with your IQ
11:46 there because what you are checking is
11:48 when will you break even that that's
11:50 that that would be the maximum rate you
11:52 should be talking about. You want to
11:53 know the break even point.
11:55 >> Yeah, I got the same thing.
11:59 >> Very good. So let's let me work it. So
12:00 what you're asking is what is the break
12:03 even rate at this point? So which mean
12:06 your break even rate will be the rate at
12:27 So which means you need to know the
12:29 total interest income and total interest
12:32 expense. So your interest income you
12:35 already know as soon said
12:37 is going to be 9%
12:40 of the 500 million that we are talking about.
12:49 And if you do that 9% of 500 million
13:01 So which means for a b for a sensible
13:06 business you can't incur more than 45
13:10 million on that product. In fact even by
13:12 time you get to that 45 million you're
13:14 already being stupid because you're
13:16 never going to make money.
13:19 So if you ever going to make money if
13:21 you are making 45 million on the product
13:24 you cannot sell it for less. I mean for
13:28 more so you can't incure interest that
13:29 is more than 45 million because that
13:32 means that the person you gave loan to
13:34 500 million to only give you interest of
13:36 45 million so even if you want to make
13:39 money on that product to sell to other
13:41 people to carry the risk you must sell
13:44 to them such that you are able to pay
13:46 them interest that is less than 45
13:48 million that is only when it makes sense
13:50 to you. So banks are just coming in and
13:51 those are the things they were doing in
13:53 2008. They were just being
13:55 intermediaries. They are not carrying
13:57 any risk. They just collecting they
13:59 giving loans to people and selling to
14:01 other individuals.
14:03 So they the numbers is where they make
14:05 money from the volume is where they make
14:06 money. So the little spread they are
14:09 making by the time you are able to send
14:11 sell to so many people they able to make
14:13 money. And let's see what the interest
14:18 expense is. As we have for branch A, the
14:21 interest expense will be 7% of the 70%
14:24 of what they are selling. So it's 475.
14:39 >> 32 7%. Thank you.
14:55 2
14:58 >> okay millions okay okay
15:03 >> in millions yes in millions so 7 * 475
15:06 time 7%
15:10 >> that would be 23 23.275 275 million.
15:14 >> Thank you. So 23.28.
15:17 Then B
15:32 What's that?
15:35 >> 9.5 million sir. 9.5 >> 9.5
15:37 >> 9.5
15:39 C is what we want to know what rate are
15:42 we going to use. So what we need to do
15:44 is to find of pos4
15:46 what should
15:50 this interest expense be such that it is
15:52 never more than 45 million. So the total
15:55 must be 45 and for to be 45 this can
16:01 only be so this has to be 45 less 23.28
16:06 28 less 9.5 and what is that?
16:14 12 let's say 12.23.
16:17 So that is a interest expense that we
16:20 can actually incur on C. So if that's
16:23 what we can incur on C then what rate
16:25 will that amount to? So we're saying the x%
16:27 x% of
16:29 of
16:32 10% of that
16:35 75 which is our principle
16:39 is equals to 12.23
16:41 12.23
16:44 that's exactly what we are saying. So
16:46 which means the percentage that we're
16:49 looking for is equals to 12.23 divided
16:53 by 47.5.
16:57 And I believe that's what you've done.
17:07 and that gives 0 255
17:09 255
17:17 So
17:20 let me Yeah. So you're right. 25.7.
17:23 Yeah. So you're all correct. Nice. So
17:26 what you're saying is that for trans C
17:30 that is rated C this company must never give
17:32 give
17:35 give it out at more than 25.7%.
17:39 Yeah. Yeah. Because like you say yes
17:42 this led to economic crisis in 2008 but
17:45 it still remains the proper financial
17:48 product. It became a problem in 2008
17:51 because banks were getting so carried
17:53 away with it. They just want to sell as
17:55 much as possible. So they were not doing
17:58 proper due diligence with with their customers.
18:00 customers.
18:02 So they are selling to people who cannot
18:04 afford to pay back because they just
18:06 want to sell. They just want to sell
18:08 because they just want to sell as much
18:09 as possible, transfer it to investors
18:12 and move on and sell another thing, make
18:14 spread on it and keep making spread.
18:17 It's a proper product. The problem is
