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Banks and Excessive Risk-Taking

The paper will use Bear Stearns as the main subject and UBS as its benchmark. Bear Stearns has in common with UBS the risk-taking and the fact that UBS benefited from high risk at one point. Bear Sterns was the first bank to fall in the US from the credit crunch after the UK’s Northern Rock. The actual question is how the current situation reached this point and how risk became to be rewarded within the financial system? Some of the trades, in these banks, had no conceivable rationale other than to ramp up the risk to create the chance of instantly making a large profit.

In order to understand how excessive risk-taking influenced these two banks, one of which had a free fall, there is a need to explain the situations that occurred, the economic condition, the bank’s strategies and what exactly took action against them. UBS AG, mainly traded on the NYSE: UBS (New York Stock Exchange) as well as SWX: UBSN (Swiss Exchange) and TYO: 8657 (Tokyo Stock Exchange), is a large global financial services bank. UBS main headquarters are in Basel and Zirich, Switzerland.

The Swiss bank is the largest manager of private wealth assets in the world,

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‘the world’s biggest manager of other people’s money’ (The Economist, 2007), as well as the second largest bank in the European community, from market capitalisation and profitability point of view. UBS has a key presence in the US, with its headquarters in New York (Investment Banking), New Jersey (Private Wealth) and Connecticut (Capital Markets). The bank’s name is an abbreviation originating from the Union Bank of Switzerland.

UBS stopped to be considered a representative abbreviation 1998 when it merged with Swiss Bank Corporation. The present business areas are investment banking, private banking and asset management. In addition, the Swiss bank is the leading provider of commercial banking and retail banking services in its country of origin, Switzerland. UBS’s overall assets invested are 3. 265 trillion CHF (Swiss Francs), the equity of the shareholders is 47. 850 billion Swiss Francs and by the end of the second quarter of 2007 its market capitalization was 151. 203 billion Swiss Francs.

The abbreviation ‘AG’ in the name of the company stands for Aktiengesellschaft and this is the correspondent to a shareholder based corporation in the US. Bear Stearns on the other hand, based in New York was one of the major brokerage, securities trading firms and global investment banks prior to its sale to JPMorgan Chase in April 2008. The bank’s global business groups, based on 2006 revenue distributions were capital markets more exactly fixed income, equities and investment banking around 85 %, wealth management around 10 % and global clearing services.

At the beginning of 2007, the firm was already damaged by the subprime mortgage crisis or the so called ‘credit crunch’. In March 2008, the FED (Federal Reserve Bank) provided Bear Stearns with an emergency loan trying to avoid a collapse of the company. The bank could not be saved, nevertheless, closed a deal with JPMorgan Chase for as little as 10 dollars per share, which was a price far-off below the 52 week high of 133. 20 dollars per share. This was the stock’s price trading before the crisis arose. Although the price was not as low as the 2 dollars per stock which was originally arranged on by JP Morgan Chase and Bear Stearns.

One of the major shareholders of Bear Stearns was UBS with 1. 54 % equity. Bear Stearns explored risky strategies in order to generate large returns. Bear Stearns also made use of leverage which in general terms helps the investor as well as the firm in making investments. On the other hand, leverage comes with greater risk. When an investor makes use of leverage in making an investment and that investment moves against him or her, the loss is larger than it would have been when or if that investment was not leveraged.

Financial leverage amplifies gains as well as losses. A firm uses leverage in trying to generate the shareholder’s wealth, but failing to do so, credit risk of default and the interest expense eliminates shareholder value. Firstly, ‘hedge fund’ as a term can be confusing. ‘Hedging’ as a purpose means to make an investment to explicitly reduce risk. This could get confusing because usually hedge funds are anything but conventional. Known for using aggressive, complex and risky strategies, they are used to produce large returns.

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