Question

1. Explain the following terms and set them in the context of the financial crisis
   1. Lehman paper
   2. “Breaking the buck”
   3. Initial public offering
   4. Market maker

Answer 1

(a): Lehman paper – This is the commercial paper issued by Lehman Brothers. It is a short term debt instrument issued by Lehman for the purpose of raising capital cheaply at short term interest rates. In the context of financial crisis the Reserve Primary Fund announced that it has booked a huge loss of $785 million on its holdings in Lehman Brothers’ commercial paper. So in 2008 the commercial paper, which normally is regarded as a safe asset, proved to be risky. There was a significant fall in the value of asset backed commercial paper and this led the ensuing financial meltdown.

(b): Breaking the buck – Breaking the buck occurs when NAV (or net asset value) of a money market fund falls below $1. In the context of financial crisis shares owned by Reserve Primary Fund in Lehman papers were worth only 97 cents. The impact of this was that investors fled the fund and this led to panic for other money market funds.

(c ): Initial public offering (IPO) – IPO is the offering of shares of a private company to the public for the first time through a new stock issuance. The 2008 financial crisis took a toll on the IPO market on a global level. Before the financial meltdown several large companies were set to offer their securities through IPO. However, given the fall in values of equities and the strong bearish sentiment gripping the equity markets these companies had to shelve their IPO plans as the market was simply not attractive in the aftermath of the financial crisis.

(d): Market maker is a dealer in securities and other types of financial assets who undertakes to buy or sell the assets at specified prices. The main aim of market maker is to profit on the bid-ask spread. In the context of financial crisis the bid-ask spread for market makers narrowed significantly and with this their chances of earning a profit also reduced considerably. Thus the aftermath of the financial crisis saw the pool of market makers shrinking considerably.