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Friday, October 17, 2008

The Great Stock Market Crashes of the Last 100 Years

1929 : The Great Depression
1973 : The Oil Shock
1987 : Black Monday
1997 : The Asian Financial Crisis
2001 : The Dot.com Bust and 9/11
2003 : Sars and the Iraq War
2008 : The Credit Crisis

Crisis Glossary

1. Securitisation
If a bank lends money to a co. / individual, it's simply called a loan. So the bank "securitises" the loans it has, packaging them into investments (IOUs) & selling them to 3rd party investors. The bank has now taken the risk of the loans off its books & no longer needs to set aside capital to protect against their default. So it's free to grant even more dodgy loans.

2. Morgage-backed securities (MBS)
These repackaged home loans are the "IOUs" that 3rd party investors bought. Investors are willing to buy MBS because each security is backed by thousands of loans, so the risk of default is much lower. Besides, they get paid a healthy interest return & can even buy a "credit default swap" to insure themselves against default. Crafty investment banks can even securitise the already securitised loans again & sell them off again.

3. Credit default swaps
These are essentially "insurance policies" that companies / investors buy to protect themselves from the default of something or someone. The buyers of these swaps make regular payments (much like insurance premiums) to a swap seller, usually an insurer, in exchange for a payout when there's a default.

4. Collateralised debt obligations (CDOs)
CDOs are like MBS, but instead of mortgages they are made up of different types of assets, including commercial property & bonds. CDOs & MBS are some of the instruments which people nowadays call "toxic debt".

5. Leveraging / Gearing
Measures the degree to which a co. / investor is using borrowed money. Companies that are highly leveraged / geared borrow a lot of money compared to how much they actually have. Leveraging plays an important role in the financial crisis because many investment banks borrowed heavily - using their shares as collateral - to invest in risky high-return securities. This was highly profitable as long as the market was rising. On the other hand "deleveraging" means - as asset prices fall and confidence evaporates, banks & companies have to put up more collateral and reduce their debt levels by selling assets and rising capital.

6. The London Interbank Overnight Rate (Libor) & the Singapore Interbank Overnight Rate (Sibor)
These terms refer to the rates that banks charge when they lend money to one another in London & Singapore. The rates are set daily by banks themselves & ar e different from the rates at which banks lend money to individuals.

7. Treasuries
Government bonds issued by the U.S Treasury Dept. They include treasury bills, treasury notes & treasury bonds, which have different maturity periods. Treasuries are seen as the ultimate safe-haven investment because they are denominated in USD - the reserve currency of the world - & also backed by the mighty US gov't.

8. Derivatives
A class of instruments that derive their value from another underlying asset, such as a co. stock, allowing investors to profit from movements in the stock price without actually owning the stock. Investors can also buy derivatives to take bets on anything from interest rates to the weather. US billionaire investor Warren Buffett has warned that these complex investments are a time bomb, calling them "financial weapons of mass destruction".

9. Short-selling
This when an investor sells a financial instrument like a stock that he doesn't own in the hope of buying i back later at a lower price & earning a profit. Short-sellers often borrow stock to make good their trades. Short- sellers have exacerbated the financial crisis because their selling actions ahve pushed stock prices down very sharply. This has prompted many countries to temporarily ban the practice.

10. Hedge funds
These are private, barely regulated investment funds that manage assets using high-risk, high-return strategiese. They typically borrow money ("leverage") to eke out bigger returns & are often blamed for indiscriminate short-selling. Originally named after th eir tendency to hedge their investments to reduce risk, hedge funds now include funds that do nothedge, & those that use hedging methods to increase risk so as to get greater returns.

(Source of info : The Straits Times)

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