Corporate Finance

Running head: CORPORATE FINANCE
Corporate finance
Name of the Student
Name of the University
Author Note

CORPORATE FINANCE
Table of Contents
Answer to question 1:.................................................................................................................2
Answer to question 2:.................................................................................................................5
Reformation of financial regulation in UK for prevention of such financial crisis:..................5
Reference list:.............................................................................................................................8

CORPORATE FINANCE
Answer to question 1:
Introduction:
This section will provide an explanation of the subprime crisis of 2007-09. The financial
crisis of 2007-09 is regarded as the worst financial crisis and came as a major shock,
presenting a global threat to the financial. This caused a sharp decline in the prices of stock
forcing corporate borrowers to borrow loans at expensive rates thus resulting in lower
investment and a decline in lending to consumers. In the early stage of the crisis, there was a
sharp increase in collateral requirement and risk premia against secured borrowings. It was
found that the financial crisis of 2007-09 was due to the credit crunch culmination that had its
root in the housing market of the US (Olbrys and Majewska 2016). The lessons learned from
the previous financial crisis have led to major changes aimed at avoiding a repeat of such
crisis.
Discussion:
The next section discusses the contribution of micro and macro economic factors in
the financial crisis. The micro economic factors leading to the subprime crisis can be divided
into several stages:
The concerns about subprime mortgages resulted from a pervasive decline in the
housing prices of the US that were responsible for the subprime crisis of 2007-09. In the
beginning of 2000, there had been a dramatic increase in the average house price in the US
that reached its peak in early 2007. Increased demand resulted in increasing prices and the
secured mortgage prices fell further due to falling housing prices (Ftp.iza.org 2019).
Another factor is the collateralization of debt obligations and securitization of
subprime loans through Special Purpose Vehicle. One of the major contributing factors in the

CORPORATE FINANCE
subprime crisis was the securitization of subprime loans and debt obligations. Investors were
attracted to such mortgage securities as it offered higher interest rates. Due to the increased
risk of default, higher interest rates were enjoyed by subprime borrowers that had less than
perfect credit all of which added fuel to the crisis (Matthews and Thompson 2005).
Nationalization of Northern Rock in the UK contributed to the financial crisis. There
were issues with the funding strategy of the bank as it involved selling off packaged
mortgages to other banks. The security market simply dried up due to sceptical behaviour of
buyers about the securities value. There was also failure on behalf of the Northern Rock to
refinance their operations.
The collapse of Lehman Brother also triggered the financial crisis. Investors started
losing confidence in the Lehman Brothers due to a weakening market of real estate as they
were doubtful about the assets due to a lack of market liquidity. The debt ratings of Lehman
threatened to downgrade the ratings and when Lehman finally collapsed, it became the largest
US bankrupt filing (Garriga and Hedlund 2018).
The Bank Discount Window Facility was another factor leading to the financial crisis.
Most of the damage in the wake of the financial crisis was caused by the shadow which did
not fall under the primary regulatory purview of the comptroller of currency. The real
economy faced a credit crunch resulting from the panic in various parts of the shadow
banking system that caused businesses to layoff by way of spending cuts and layoffs that
triggered a recession (Valdez and Molyneux 2015).
The Credit Guarantee Scheme allowed institutional investors and banks to ensure
against the default of loans. Consequently, an end to proclaim credit risk was led by many
people in the financial industry. There was replacement of the credit risk by the counter party
as far more liability was accumulated by companies such as American International Group.