Define a firm’s balance sheet gap


1. The article “Anatomy of the Morgan Stanley Panic” from the WSJ describes a situation where CDS were used for other than insurance purposes. During the period of time under investigation, the article describes an interesting linkage between the CDS market and other markets. Traders exploited this linkage during the crisis almost forcing Morgan Stanley into insolvency.

a) Identify and describe how this linkage worked.
b) Why was it so effective a strategy during this period of time?
c) How did Morgan Stanley manage to break the link and defend itself?

2. The reading titled Chapter 3, SWAP Applications, from CFA Publication discusses a number of areas where SWAPS are useful to a finance professional. Two areas of importance are the sections on managing Balance Sheet Asset-Liability Gap, and Asset Arbitrage and Currency SWAPS.
a) Define a firm’s Balance Sheet Gap. Why is it of importance? Do all firms need to be concerned?
b) In managing the GAP, how is it measured and how does one know if it has been remedied?
c) Define Asset Arbitrage and Currency Swaps and how the two are related in this particular example. Is the use of Swaps in this application successful?

3. In the article “Credit Default Swaps and Structured Credit: A Primer for Wealth Managers” by Jeffrey T. Prince, CFA, he recognizes five problems that were associated with the collateral that was used to create ABS CDOs.

a. Name and discuss briefly the five problems associated with the collapse in the ABS
CDO market. Note the collapse was due to the very high default rates experienced by ABS CDOs. The five problems or issues are said to be the reason default rates were so high.
b. The article also briefly mentions two opposing views as to who, in general, was at fault for the bubble. Please list and briefly describe the two opposing views. Which viewpoint does the author agree with?
c. What was, or is, the “Anthos Funding” deal? Describe it in brief terms. What are its unique characteristics? Why is it mentioned in the article by Mr. Prince?

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