Key Concepts in International Monetary and Financial Systems

Assignment Brief

MODULE TITLE: INTERNATIONAL MONETARY AND FINANCIAL SYSTEMS

MODULE CODE: 5106LBSBW

1. What is a hedge fund? Discuss the extent to which hedge funds deserve their bad reputation.
2. Describe the macroeconomic and microeconomic causes of the credit crisis of 2007 to 2009.
3. Discuss the strengths and weaknesses of the current system of bank regulation.
4. What are the main roles of a Central Bank? Explain whether Central Banks should be independent.
5. What do you understand by the term ‘Efficient Markets Hypothesis’ (EMH)? Outline the main implications of the EMH for stock prices. Can markets ever be efficient in the ‘strong form’ sense? Explain your answer.
6. Explain with diagrams the main advantages and disadvantages of fixed and floating exchange rate regimes.

Sample Answer

Key Concepts in International Monetary and Financial Systems

Module: 5106LBSBW – International Monetary and Financial Systems

Hedge Funds and Their Reputation

Hedge funds are pooled investment vehicles that employ advanced strategies, including leverage, short-selling, derivatives, and alternative investments, to achieve high returns for accredited or institutional investors. Unlike traditional mutual funds, hedge funds have greater flexibility to pursue both upward and downward market movements, aiming to hedge risk while maximising profit.

Hedge funds have often been associated with a controversial reputation. Critics argue that their speculative practices, combined with significant leverage, can exacerbate market volatility and contribute to systemic risk. The role of hedge funds in financial crises, particularly during the 2008 global financial meltdown, highlighted the potential for mismanagement and excessive risk-taking. However, this negative perception is not universally justified. Many hedge funds operate responsibly, providing market liquidity, diversifying investment opportunities, and identifying mispriced assets. While some funds have engaged in ethically questionable or excessively risky behaviour, it is important to differentiate these cases from the industry as a whole, recognising the constructive contributions hedge funds can make to financial markets.

Causes of the Credit Crisis 2007–2009

The credit crisis of 2007 to 2009 resulted from a combination of macroeconomic and microeconomic factors. At the macroeconomic level, prolonged periods of low interest rates, particularly in the United States, encouraged excessive borrowing and speculative investment in housing. The global housing boom, amplified by rising demand for mortgage-backed securities, created inflated asset prices that were unsustainable. Global financial integration further magnified the crisis, allowing shocks to spread rapidly across international markets.

At the microeconomic level, financial institutions engaged in high-risk lending practices, including subprime mortgages, without adequate risk assessment or capital buffers. The widespread use of complex financial instruments, such as collateralised debt obligations (CDOs) and credit default swaps (CDSs), obscured the true level of risk and contributed to mispricing of assets. Weak regulatory oversight allowed leverage to accumulate and risk management practices to remain insufficient, creating a fragile financial system. The combination of these factors led to widespread defaults, liquidity shortages, and a severe loss of confidence, culminating in a global financial crisis.

Bank Regulation: Strengths and Weaknesses

The modern system of bank regulation has evolved to mitigate systemic risks and protect financial stability. Regulations such as Basel III have strengthened capital adequacy requirements, introduced liquidity coverage ratios, and reinforced risk management protocols. Supervisory frameworks and stress testing enable regulators to assess bank resilience under adverse economic conditions, while consumer protection measures enhance confidence in financial institutions.

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