1. A GSE is a Government Sponsored Enterprise, a hybrid of public and private corporations. GSEs such as Fannie Mae and Freddie Mac are private corporations, but they were created by the U.S. Congress for a specific purpose that is valuable to the country as a whole. For example, Freddie Mac (Federal Home Loan Mortgage Corporation) and Fannie Mae (Federal National Mortgage Association) were created to provide additional capital for mortgage lenders (FHFA, 2011).
2. a. A long position in a stock is buying a stock with the idea that its price will go up. The buyer intends to sell the stock at some point in the future when a higher price provides a profit (The Motley Fool, 2015).
b. A short position in a stock is selling a stock with the belief that its price will drop. The seller does not have to own the stock, but can borrow it from the brokerage or another lender. The stock will be available to hand over to the buyer within the three-day settlement period. Short sellers plan to buy back the stock at a lower price, to make a profit. Some people sell short to hedge their long positions (The Motley Fool, 2015).
c. A naked short position in a stock is selling a stock without making arrangements to borrow it. As a result, there is no actual stock to deliver to the buyer within the settlement period. A failure to deliver results. As indicated above, a regular short sale does borrow the stock for delivery to the buyer (SEC, 2015).
d. Retail investors and traders are not permitted to naked short a stock because it is against SEC regulations. Any accidental failures to deliver must be closed within a specified period of time (SEC, 2015).
e. Market makers are permitted to naked short stocks when this is necessary to provide liquidity in the market. However, they are still required to locate, borrow, and close out naked short sales within a period of time specified by the SEC (but longer than three days). According to the SEC (2015), naked short selling with the intention to manipulate the stock’s price is always illegal.
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3. a. Many other nations followed the United States’ example and suspended naked shorting after June 2008 (Wood, 2008).
b. These countries included Great Britain, Australia, Spain, Portugal, Germany, Russia, South Korea, France, and Taiwan (Wood, 2008).
4. A short squeeze occurs when the price of a stock that has been heavily shorted increases suddenly, causing the short sellers to buy back the stock, limiting their losses. As more short sellers close their positions, the price goes even higher, often “shaking out” the rest of the shorters (Investopedia, 2015).
5. a. The approximate value of credit default swaps in circulation worldwide during the crisis period was $62.2 trillion (Watkins, n.d.).
b. The U.S. GDP at that time was just $14.58 trillion. Even the worldwide GDP was only $60 trillion, less than the value of CDS in circulation (Watkins, n.d.).
6. a. Oil is traded in U.S. dollars (primarily), although it can also be traded worldwide using the Chinese yuan, and Iran uses several currencies other than the dollar (Holodny, 2015).
b. Credit default swaps are traded in other currencies as well as the U.S. dollar, commonly the euro or the yen (White, 2014).
7. a. The U.S. dollar may not remain the currency of choice because other countries want the power and status of being part of the Special Drawing Rights currency basket, set up by the IMF. The euro, yen, and British pound are alongside the dollar in the SDR. These currencies have global prestige, lower borrowing costs, advantages in price setting, and increased investment compared to non-SDR currencies. The yuan has been proposed as another potential SDR currency. SDRs can be used as a reserve currency as well as for bonds (Rooney, 2011).
b. Yes. Nations calling for a switch from the U.S. dollar include China, Russia, Japan, Iran, and the EU. In fact, the International Monetary Fund (IMF) itself called for a change in 2011. At that time, the IMF set up the Special Drawing Rights currencies (see 7a). The SDR is a weighted collection of currencies that, as a whole, can be used as a currency for reserves, trading, bonds, and more (Rooney, 2011).
- Federal Housing Finance Agency (FHFA). (2011). History of the government sponsored enterprises. Retrieved from http://fhfaoig.gov/LearnMore/History
- Holodny, E. (2015). Iran is ditching the dollar in foreign trade. Retrieved from http://www.businessinsider.com/iran-is-ditching-the-dollar-in-foreign-trade-2015-1
- Investopedia. (2015). Short squeeze. Retrieved from http://www.investopedia.com/terms/s/shortsqueeze.asp
Rooney, B. (2011). IMF calls for dollar alternative. Retrieved from http://money.cnn.com/2011/02/10/markets/dollar/ - Securities and Exchange Commission (SEC). (2015). Key points about regulation SHO. Retrieved from http://www.sec.gov/investor/pubs/regsho.htm
- The Motley Fool. (2015). Long position vs. short position. Retrieved from http://www.fool.com/investing/general/2015/06/01/long-position-vs-short-position.aspx
- Watkins, T. (n.d.). Credit default swaps (CDS) and their role in the financial crisis of 2007-2008. Retrieved from http://www.sjsu.edu/faculty/watkins/CDS.htm
- White, R. (2014). The Pricing and risk management of credit default swaps, with a focus on the ISDA model. Retrieved from http://www.opengamma.com/sites/default/files/pricing-and-risk-management-credit-default-swaps-opengamma.pdf
- Wood, A. (2008). Short sellers rocked by the restrictions. Retrieved from http://www.ft.com/cms/0439c456-9c77-11dd-a42e-000077b07658.html
