The Rise and Fall of AIG Harvard Case Solution & Analysis

a.      Strength analysis of Credit Derivative Deal

Without OTC derivative instruments, Bear Stearns, Lehman Brothers and American International Group (NYS: AIG) would never have failed. Bear Stearns and Lehman Brothers fizzled on the grounds that market accepted that there was a high likelihood at that time whether in right or wrong manner that the advantages of these establishments were worth short of what their liabilities. Subsidiaries were not the proximate reason for their breakdown. Then again, it is without a doubt genuine that without subordinates, their advantages and liabilities would have been truly distinctive. By listening to the press and to such onlookers, it practically appears to be as though trade exchanging could uproot the issue of counterparty hazard and make transparency and request in the business for subsidiaries.

Derivative instruments have been around for a considerable length of time. Notwithstanding the best derivatives exchanging today are moderately new. The primary investment rate swap contracts dates back to the early 1980s. The main CDS was presented in 1994. At the point when these instruments were presented, there were long arrangements before contracts were agreed upon. Different sorts of instruments don't exchange. They are utilized to take care of particular risk management issues of an end-client. It is not difficult to improve over the counter. Anyone who feels that another kind of instruments may comprehend a one-time issue for a solitary firm can present that instrument. The OTC business sector is ideal for innovative financial products. On the other hand, there is a considerable amount of standards in derivative instruments exchanging. As investment rate swaps are well-known, hence, the business framed an affiliation namely, the International Derivatives and Swaps Association (ISDA), which formulated standardized contracts. At the point when parties exchange instruments, they enter into ISDA Master Agreement. The Master Agreement is an ISDA record that has numerous alternatives that the counterparties to derivative instruments trades select to structure the basis of the contract they enter into when they exchange derivatives. Exchange offers an exceptionally proficient result when parties involved in the successful drawing of extensive pools of liquidity.

b.      Risk involved in Credit Derivative Deal

Lack of Transparency:

In OTC trading of credit derivative instruments, it is not public. These kinds of deals are made between the two parties with consensus on it and they are made specifically on demand to mitigate the risks. This creates problems, as risk associated with it is not well-known publically. These kinds of risks associated with the deals lead towards the instability of the financial institutions. On the other hand, transparency of credit derivative deals mean that institutions, which are the agreed parties within this agreement have to disclose the transaction process that is also critical for the institutions because it will not create the opportunity to avail the profit from the market variances.


From these credit derivative deals, other concerns raised that financial institutions are manipulating the market information accordingly to generate more profits. From the 2008 crises, it can easily be observed that the traders in the market were exchanging the information to manipulate the CDS market.

c.       Talk Points

  • AIG was involved in the faulty transactions that led to the 2008 crises.
  • AIG executives were controversial.
  • The insurance companies had clients that benefit the AIG to manipulate the market information.
  • Insider trading was also the main issue of this crisis.

d.      Exhibit 1 Analysis

From the analysis of the Exhibit 1, it can be viewed that the Dow Jones Industry Average is below AIG stock data. The industry average shows that the AIG stock prices were over-valued because of the rating that was made by the top rating agencies. These ratings were falsely made that were not showing the risks involved in investing into the AIG stock. In the middle of the year 1997, the stock prices value of AIG stock was overly valued and it continued to be over-valued till the crises. This overvalued stock price was the reason that crashed the market because AIG was given the AAA rating, which is assumed to be risk free after government securities. In year 2008 when the economy was in crises, the stock prices of AIG went down exponentially that created the return related issues for investors. Investors of AIG were pulling back their investment to reduce the losses that ked AIG to bankruptcy.......................................

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