CHAP 1

1) How can a firm raise fund from informal finance? Why does informal ofinance
exist?
(Allend2009 & Burkhart 2004)
Informal financing—that is, financing that occurs without a formal financial intermediary
between savers and borrowers—in economic growth.

How to raise fund?

Based on the mechanism they rely on for the purpose of info production and repayment
enforcement. (mainly because the effectiveness of info sources is how they overcome
asymmetric information)
Criteria:
(a) information technology for monitoring, risk control, and pricing
b) the coercion and violence mechanism in case of delinquency
- Constructive informal finance: “transactions that derive their information and
enforcement technology from personal, business or social relationships to reduce
asymmetric information and reduce risk through economic collateral
- E.g: trade credit, small loan companies, banks’ credit extension arms, registered
pawnshops or financing companies, direct and informed lending between direct
family members and close relatives
- legally permitted and target entrepreneurship activities
- Underground financing - coercion mechanism: “transactions which have little
information technology to rely on”
- E.g: loan sharks, unregistered pawnshops, lending agencies and loan brokers
- illegal and target speculative activities such as gambling
- Credit cooperatives such as rotating savings, credit organizations, rural cooperative
foundations, and mutual benefit funds

- interpersonal lending, trade credits, money lenders, loan sharks, rmoney houses,
rotating savings, credit organization, pawnshops, indigenous banks,, mutual assistance
societies
Why exist?

The role of financial intermediaries such as banks and direct financing through equity markets is
to bridge the gap between economic agents with a surplus and those with a deficit of capital.
However, asymmetric information between banks/markets and
firms may preclude financing for valuable projects. The asymmetric information problem is
particularly severe for small firms, firms without bank relationships, and during credit tightening
periods. It is also particularly severe in developing countries that usually have less developed
financial systems, inadequate business laws, and insufficient intermediary service.
It is typically less profitable for an opportunistic borrower to divert inputs than to divert cash.
Therefore, suppliers may lend more liberally than banks
Suppliers have a monitoring advantage over banks. In the course of business, suppliers obtain
information about the borrower which other lenders can only obtain at a cost
- supporting business operations and uses business or social relationships to reduce
asymmetric information and to assist collection, recovery or recourse
- made to speculative activities, charges extremely high interest rates or fees, and
employs violence rather than legal recourse to collect payments or renegotiate in the
case of delinquency
- To overcome financing constraints, private firms has widely adopted many alternative
financing sources apart from banks
- Trade credit: the availability of trade credit increases the amount that banks are willing
to lend. For a given bank loan, additional trade credit permits the borrower higher levels
of diversion as well as investment. However, due to the relative illiquidity of trade credit
the borrower’s return from investing increases by more than the return from diversion.
Anticipating that available trade credit boosts investment rather than diversion, banks
are willing to increase their lending.

2) Is crowdfunding direct finance or indirect finance? What are the main types of
crowdfunding? What are the risks to investors?
(Dunkley2016, Powell2019, Johan2020, BelleFlamme2014)

Is crowdfunding direct finance or indirect finance?

Crowdfunding is direct finance
What are the main types of crowdfunding?
BelleFlamme
- Pre-ordering
- Entrepreneurs invite consumers to pre-order the product, to collect the necessary
capital for launching production
- Enable the entrepreneur to price discriminate between 2 groups of consumers
(crowfunders - who prepurchase the product) and regular consumers - wait until
the products reaches the market to buy it) -> extract profit

- Profit sharing
- Entrepreneurs solicit individual to provide money in exchange for a share of
future profits or equity securities
- Investors may or may not decide to consume the product at a later stage
Dunkley
- Simplest method: investors hand over cash in return for goods and services
- Debt crowdfunding: allow investors to lend money that they will receive back with
interest
- Equity crowdfunding: investors buy shares they hope will be worth more in the future
What are the risks to investors?
- Crowdfunding platforms can go broke and investors may be not able to get their money
or return back
- Asymmetric information:
- Initially, entrepreneurs is not able to identify the consumers with a high
willingness to pay, which is private to each consumer. However, later, the pre-
odering crowdfunding helps to attract the most interested investors, who self-
select to become crowdfunders.
- Uncertainty: the quality of the product is known after production has taken place
- Entrepreneurs know the product quality better than the crowd
- Inferior firms that cannot obtain investment from angel investors or VC make take
advantage of low listing requirements and choose equity crowdfunding as a last
resort. This adverse selection problem reduces the overall quality of
crowdfunding projects and is detrimental to investor confidence in the equity
crowdfunding market.
-
Additional Question: Why not disclose information?
- Quantitative information such as financial statements, management education
background, no of employees,.... -> costly to obtain
- Qualitative information such as business model, strategy,... -> reflects self-evaluation
and hardly verified
Risks of being exposed to lack of meaningful information about the crowdfunding, investment.
(Lack of information disclosure) -> Asymmetric information

3) Read McCauley2021 and explain why the author thinks Bitcoin is worse than a
Ponzi Scheme? Do you agree? Elaborate your opinion.
Why ponzi?
Investors buy in the expectation of profits.
That expectation is sustained by the profits of those that cash out.
But there is no external source for those profits; they come entirely from new investments.
And the operators take away a large portion of the money

Summary: People buy bitcoin with the expectation of a profit. Because bitcoin is a “zero-
coupon perpetual” rather than a “income-generating” digital asset, the only way to profit
is to “cash out” to someone else – the salutary greater fool. Bitcoin is worse than your
everyday pump-and-dump penny stocks for McCauley. If the economic project fails, it’s
not just zero-sum for investors who lose their money, but “negative-sum” for society
because of bitcoin’s steep power bill.

First, Bitcoin doesn’t have the same endgame as a Ponzi scheme

- Ponzi scheme: income-earning asset - can earn part of the promised return -> suffer a
run
 - Bitcoin: zero-coupon perpetual - promise nothing as running yield, never matures with a
required terminal payment -> not suffer run; only way can cash out is by a sale to
someone else.
- Collapse of Bitcoin can be trigger by collapse of stablecoin - coin that pegged to
the value of fiat currency
- Stablecoin - lack of regulation and disclosure -> easily breaking the bud
- If bitcoin collapse -> no legal effort to find who cashed in bitcoin early in order to
redistribute their profits. Holders have no claim on those who bought early and
sold

-> Bitcoin like penny-stock pump and dump scheme

In a pump-and-dump scheme, traders acquire basically worthless stock, talk it up and perhaps
trade it among themselves at rising prices before unloading it on to those drawn in by the
chatter and the price action. Like the pumpand-dump scheme, bitcoin taps into the pure
desire for capital gains. Buyers cannot stand the sight of friends getting rich overnight:
they suffer an acute fear of missing out (FOMO).

=> In any case, bitcoin makes no promises and cannot end as a Ponzi scheme ends.
On

Second, it constitutes a deep negative sum game from a broad social perspective (unlike
zero-sum game of ponzi scheme)
- Bitcoin: negative sum game
- Real resources are used up to make bitcoin run -> costly unlike Madoff’s
operations
- Game: county whose electricity consumption = all miners who receive reward ->
electricity consumption is real cost
- If price of bitcoin = 0, gains of those who sold would fall short of the
losses of holders by this growing sum.
- If want to redistribute bitcoin like ponzi schem or pump-dump scheme ->
flatter the cryptocurrency system?
- Ponzi schem Madoff: redistribution in a zero sum game (the trustee sold his
penthouse).
Stolfi’s fourth observation above that “the operators take away a large portion of the money”
lumps together Madoff’s take and bitcoin miners’ revenues, but these are very different in
economic terms.

In a crash, the holders of bitcoin will collectively have lost what they have paid the miners for
their bitcoin. This sum may be not far from the sum originally invested with Madoff, after
accounting for inflation. But bitcoin holders will have no one to pursue to recover this sum: it will
simply have gone up in smoke, a social loss. The holders of bitcoin would then only wish it had
been a Ponzi scheme.
CHAP 2
DW: How the rich become richer – money in the world economy). Read the supplementary
materials (Larosiere, Pitkanen, Rajan, Rennison). Summarize the negative effects of very
low/negative interest rates

Background info: Why low i?

- Buying government bonds -> pump money into the market -> money has gone to shares
or real estates; high speculatives in the future (derivatives)
- Cheap money increase level of debts, may lead to crisis
Summarize:
- State can borrow on the cheap, take more debts. The rich may bear no liability if they
default
- Middle class has savings and insurance policy, which are the losers in low interest rate
world. Poorer citizens suffers because real estate prices are going up, and rents prices
go up too.
-> Attacks on speculative financial transactions coud slow the ponzi scheme. Howere it nwas
against by ECB, central banks. => Increase the gap between rich and poor

Materials:

Pitkanen2020:
- Block competition in the IT sector. When a new technology threatens an established
juggernaut’s position in the market, the latter can borrow at negative rates and buy,
choke or otherwise eliminate the fledgling technology from the market. -> destruction of
creativity
Juggernaut: a very large and powerful company, organization, or industry

Larosiere2020:
- In economic depression, low inflation and interest rate =0 -> central bank cannot achieve
negative real interest rate. So, they may want to retrieve some margin by deliberately
setting negative interest rate -> monetary policy would regain its driving role.
- Some objections of negative interest rate:
- Liquidity trap: when i<0, investor tend to stay away from bond to avoid the tax
caused by negative rate. -> Accumulation of savings, held in liquid asset (bank
notes, cash accounts) but barely help foster productive investment.
One solution is eliminate large denomination banknotes and ensure banks pass
the full cost of negative rates to depositors -> however, it can create economic
and political problem in country where household savings finance about a large
amouunt of national investment.
- Risk of inflation: in the long run, anti-recessionary monetary policy must
elimiate the difference potential growth - currently depressed growth rates
through money creation. However, risk of inflation is nonetheless in this current
 situation. Moral hazard of a system where indebtedness can be permanent and
infinite regardless of debtors’s credit quality, poses serious moral and political
problems as it nationalies risk and responsibity
- Damage productive investment:
- low i encourage companies to take on cheap debt to pay for share
buybacks instead of investment, allow zombie companies to survive,
lower overall productivity
- Encourage asset bubbles
- Obliterate the distinction between profitable and unprofitable activities
- Make little distinction between good -poor quality debtors
Rajan2020:
- Economy trapped in a selffulling slow growth, low inflation funk, aded by aging
demographics, the savings flut and revolutionary technology
- Impair banking systems because banks earn less on their asset
- Pose massive challenges for insurance companies and pension plans that are obliged to
use bonds to honor income guarantees to the end-savers
- Force people to save even more to compensate for the prospect of reduced retirement
income

Rennison2020:
- Sinking real yield -> Fund managers shifted from government to corporate debt, others
will now seek out higher returns in riskier assets such as lower-quality corporate bonds

CHAP 3
Base on Kacperczyk2013, compare Reserve Primary Fund and Fidelity Institutional
Prime Money Market Fund and explain why Reserve Primary Fund collapsed.
(Read the topic Money Market Mutual Funds in Chapter 20 Mishkin 9th)
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1769025

Basic info about mutual fund and money maket mutual fund:
- Mutual Fund: new shares were issued as new money was invested - most dominant
structure
- Money market mutual fund: opened-end investment funds that invest only in money
market securities
- Have check-writing privileges - do not charge fee or have any min check amount
as long as the balance in account is above stated level
- Not insured by the government
- Expose to rund because demand deposit is backed by illiquid assets
Reserve Primary Fund: broke (faling to redeem money market accounts) after the day after
Leman Brothers declared bankruptcy -> initiate a run around the world on money market fund,
with rapid withdrawals threatening the liquidity of hundreds of other funds.
 -> the U.S. government decided to intervene by providing unlimited insurance to all
money market fund depositors. The intervention was successful in stopping the run but it
transferred the entire risk of the $3 trillion money market fund industry to the
government.

COMPARISON: risk-taking opportunities

Reserve Primary fund (RPF) & Fidelity Institutional Prime Money Market Fund (FID)
Similarities:
- Well-known to the public
- RPF :well known in the industry because its owner, Bruce Bent, was the founder
of the first money market fund.’
- FID: well known because of its sponsor, which is one of the largest asset
managers.
- The funds were quite similar before August 2007. Each fund managed about $25 billion
in assets and charged similar management fees.
- Prior to August 2007, the yields of the two funds roughly matched the industry average.
Differences:

RPF FID

Yield Since August 2007, yield of RPF increased the yield of FID stayed
by about 50 basis points constant

Fund flow After August 2007 : Relative to the average FID’s assets value grew only
asset growth of all institutional prime funds, by 40%
by August 2008 RPF increased its assets
under management by 140%

Underlying RPF increased its holdings of risky assets the share of risky assets held
fund porfolio from 0% to 60% while it reduced its by FID remained steady in
exposure to U.S. Treasuries and repurchase 2008.
agreements from 40% to 10%.

Sponsors’ RPF was managed by a stand-alone fund FID’s manager— Fidelity—is

non-MMF company with almost no other funds under one of the world’s largest
business management, assets managers with lots of
other business

COLLAPSE: explain why Reserve Primary Fund collapsed

- One of the important instruments among RPF’s holdings was commercial paper issued
by Lehman Brothers. Lehman Brothers’s bankruptcy triggered a panic in financial
markets and led to a credit market freeze. -> Net asset value of RPF fell below $1 per
share. The revelation of the fund’s exposure to Lehman’s risk caused an
immediate run on the fund
- On September 16, 2008, the fund was forced to redeem $10.8 billion in withdrawals and
faced $28 billion of additional withdrawal requests. The fund’s sponsor did not have
sufficient financial resources to guarantee payments and was forced to halt
redemptions