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Finance Essay

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Quiz 1

1. The raw fundamental data on the human genome cannot be patented but the genes and gene-based discoveries can. 2. The map of the human genome produced by Collins and his co-workers is available from the internet for free all over the world. In other words, the map of the human genome created by the HGP is a public good. 3. Celera genomics has no patent over the human genome. However, celera does have proprietary rights over its version of that genome. It is private good.

Quiz 2

1. Any new idea applicable to the essential function of finance is termed a financial innovation. This is the loosest possible definition of financial innovation. Credit card automatic teller machines venture capital firms. 2. The distinguishing feature of ‘modern banking’ emerges from the financial innovation known as ‘securitization,’ namely: banks pool assets (from mortgages to car loans) and sell the repackaged assets. Securitized debt’ is one of the financial innovations at the heart of the financial crisis 2007-08, and refers to the creation of bonds of different seniority (known as ‘tranches’) that are fixed-income claims backed by collateral in the form of large portfolios of loans (mortgages, car loans, credit cards, etc.). 3. The CDSs are insurance contracts. The main function of the CDSs is to hedge against default. More specifically, the buyer of the CDS makes payments to the seller in order to receive protection. The buyer receives a payment if a credit instrument (for example, a loan or a bond) goes into default or in the case of a specified credit event such as bankruptcy. In particular, CDSs allow people to insure against the failure of new-fangled financial products.

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Quiz 3

1. Real A financial innovation that provides economically valuable benefits constitutes a real financial innovation. Concrete examples of real financial innovations are the Credit Card and the ATM. Nominal Nominal financial innovations are financial instruments that increase compensation without providing lasting economic benefits. Toxic A toxic (or economically malignant) financial innovation is a nominal financial innovation which singly or jointly with other financial innovations provokes a financial crisis. Sub-prime mortgage innovation. It is generally agreed that the sub-prime mortgage innovation in combination with other financial innovations and factors led to the financial crisis 2007-08, and thus, the sub-prime mortgage is an example of toxic financial innovation.

Quiz 5

1. Risk means that we can compute the probability distribution of a particular event. For example, when you buy a lottery ticket there is ‘risk’ in the sense that you can compute the probability of winning a prize. Uncertainty means that the probability distribution of an event cannot be computed because there is not enough information. For example, suppose that you buy a ‘scratchy’ that offers among other prizes a maximum reward of $250,000 and that you want to compute the probability of winning this prize after one day of the release of the ‘scratchies.’ In this case, you experience ‘uncertainty’ because you have no way of knowing whether someone else has already won the maximum prize, and therefore, you cannot compute a unique probability of success. 2. The fundamental reason serving to account for the metamorphosis of risk into Knightian uncertainty can be easily understood: the investors (for example, mutual funds) who bought the CDOs had no real comprehension of the size and location of the risks underlying these financial products.

Quiz 6

1. The loosest possible definition of ‘shadow banking system’ is ‘the collection of financial institutions and activities that in some respects resemble banking activities but are subject to less regulation than commercial banks.’ 2. The investor lends $D for interest (i %) to the financial firm and requires collateral.The financial firm gives CDOs as collateral and agrees to recuperate the CDOs some time later for $E, where E = D +iD The preceding financial trade is known as ‘sale & repurchase agreement,’ or briefly, ‘repo’ agreement

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