Current Trends in the Market - Essay Example

?Current Trends in the Market from Risk Management Prospective Introduction The global financial crisis started to show its impacts from mid 2007 to early in 2008. It has so far led to a downfall in stock market and collapse of financial institutions. This trend has led to countries even the developed ones to initiate rescue methods in order to save their financial systems. The fact is that the emerging global financial crisis will impact on lives of all due to the increased inter-connectedness of the world. The problem could only be solved by ensuring that the ideologues in support of current economic models stopped being vocal, influential and put into consideration the views of others. The Most Important Trends in Global Financial Crisis That Have Affected Financial Markets, Institutions and the Economy from 2007 To 2009 Important lessons that can be learnt from the recent global economic crisis are purely based on risk prepared and management practices capable of averting any financial challenge. A general reluctance to handle risk with caution can be translated by all facts to have been the cause of economic downturns observed from 2007. According to Hubbard (p6)1 reluctance to employ the best risk assessment techniques prevents the management from realizing how potent and hazardous a risk would be. The author therefore attributes failure to mitigate risk to wrong technique for measuring the risk and its gravity. To illustrate this position, the author finds fault with the manner in which top risk management firms and federal agencies conducted their risk assessment resulting in wrong approach to mitigate the risks. A cascade of ill-informed interventions could only worsen the case for the economic crisis that hit the financial markets for the better part of 2008 through 2009 and whose impact is still being felt to date. It is clear that the most important trend in the modern economic world entails risk assessment, which must be done right at all cases to avoid miscalculations resulting into multiplier disasters. House ownership was at the centre of interest for the financial markets, having been established in the USA to such low risk levels that the major global financial players willingly ventured in it. As Fraser and Simkins (p272)2 observe, a high demand for housing attracted high prices and supply was fast catching up to share in the benefits. The Federal Reserve was allowing the lowest interest rates for the first time in the history of the market. The homeowner society of Japan which has been prone to stagnation for long is being affected by economic crisis resulting from globalization. In most of the developed countries where capital market is deregulated by neo-liberal policies, their financial institutions are facing great effects from the global financial markets. For instance for these countries to maintain their market for their goods they have to maintain strong relations with the particular countries which provide market for their goods. This may lead to a financial crisis in that the developing countries may end up accruing debts which may affect the market. Global financial crisis through the economic turns of the overseas countries have damaged the export-based macroeconomics of Japan ACCORDING TO Forrest and Yip (p199). As the global financial crisis around the world has affected the economy and thus has brought about significant drops in stock markets. The downfall of the United States sub-marine mortgage market followed by the reversed housing boom of the industrialized countries economy has had a diverse effect around the globe. The sub-marine crisis resulted from financial assets such as security assets which involved banks transferring their loans into purchasable assets. This results to banks off-loading loans which are risky onto other financial institutions. The crisis have also been on the increase because of the fact that banks are engaging in huge risks which in turn increase their exposure to financial problems. Collapsing banks suck funds from the economy in their efforts to restore their capital resulting to more financial crisis around the world. Banks attempted securitization as a way of managing risks which has led to more problems the sector is experiencing today. The essence is that banks and other financial institutions thought that through securitization they had solved all risks and thus relaxed without following market trends. Comment on the role, application and failures of credit defaults swaps in risk management practice in financial institutions or corporations. The most infamous application of credit default swaps (CDS) and its failure in the context of 2008/9 economic crisis is perhaps the one observed at American Insurance Group (AIG). According to Hubbard (p58), CDS is a market instrument whose application by mortgage banks is aimed at reducing possible risk of mortgage customers from defaulting. In simpler language, the author relates CDS as an insurance cover that mortgage lending banks take to protect themselves in case the borrowers fail to obey their repayment obligation. Regulations for a standard insurance cover are however fundamentally different from those of CDS. This implies that the risks involved for the two instruments are also fundamentally different. Failure to account for the risk involved by insurance companies, such as the giant AIG, proved to be a bitter pill to swallow for its actuaries. The assumption that the mortgage business as a risk stood the same chance of probability as ordinary insurance risk is a major inaccuracy that anybody would have spotted from afar. According to Hampton (p60)3 the banks immediately started to venture into dangerous ground by offering virtually new form of mortgages that nobody thought would be risky. Adjustable interest rate mortgages (ARMs) were on offer in the market, with assurances to borrowers that any mortgage out of a customer’s financial ability could now be approved, for the first time in the history of the mortgage market. Initial package was irresistible since the interest rates were very low for the initial couple of years. The lucrative part came on the mechanism of the clearance of the debt when it became necessary to raise the interest rates later on in the program. The owner would sell the house if the occupant defaulted, selling it at a profit. Capital available to the banks with regard to regulation of the limits of lending that banks have, it became apparent that there was no boundary Hampton (p61). Unregulated financial players in the nature of financial banks started to enter into the mortgage business having realized that the mortgage industry was entering a lucrative era in the USA. Further developments were in the offing when these unregulated global players of the financial market bought numerous mortgages and issued them as packages referred to as collateralized debt obligations (CDOs). The operation of the mortgage market changed since banks could now venture elsewhere with the arrival of investment banks. Stated income loans became the next line of business. With all the uncertainty of the cascade transactions outcome, tension then began to grow form where the mortgage market revealed the cracks that analysts refused to appreciate. It was too late to initiate measures to salvage the situation Haslett (134). Credit Default swaps are capable of playing an important role making bond investors secure against default risk. Credit default swaps have also been used on financial products for reducing the risk of default. A port folio of a loan makes the basis of Credit default swap on individual loans that banks take on individuals. Credit Default Swaps contracts indicate that there is a possibility of reducing default risk on financial contract by making reference to a third party who is more solvent. Credit default swaps have important applications, for instance they can be applied in corporate entities for effectively covering against their counterparties risk of default in particular transactions. As suggested by Meissner (p15), CDS provide a kind of security which is competitive in comparison with traditional techniques managing credit risks. CDS protection is cheaper compared to the traditional credit insurance as it does not need administrative costs. The use of credit Default swaps in risk management is also associated with risks itself. For instance failure to choose a seller with the right qualities may lead to failure in risk management. The protection seller has to be careful when choosing an entity as it should not be linked with the reference asset. Failure to evaluate the probability of there occurring adverse changes on reference asset not resulting from credit event may lead to major risk. Conclusion The increasing global financial crisis is making the condition worse for economic circumstances in as far as property ownership is concerned. The declining stability of income and employment discourages renters from engaging in individually-occupied housing market in countries like Japan. The increased global interaction and interconnectedness has made the mechanism of crisis propagation more strong. The issue of credit default swaps and its use in the risk management of financial markets has sparked a hot debate. The CDS is yet in its growing stages and their effects in the long-run have been difficult to establish. The role of CDS on the empty creditors and their influence to market access has also been discussion to establish the future of Credit Default Swaps. Reference list Forrest, R. & Yip, N. (2011). Housing Markets and the Global Financial Crisis: The Uneven Impact on Households. Cheltenham, UK: Edward Elgar Publishing Fraser,J. & Simkins, B. (2010). Enterprise Risk Management: Today's Leading Research and Best Practices for Tomorrow's Executives. New Jersey: John Wiley and Sons Haslett,W. (2010). Risk Management: Foundations For a Changing Financial World. New Jersey: John Wiley and Sons Hampton, J. (2009). Fundamentals of enterprise risk management: how top companies assess risk, manage exposures, and seize opportunities. New York: AMACOM Div American Mgmt Assn Hubbard, D. (2009). The failure of risk management: why it's broken and how to fix it. New Jersey: John Wiley and Sons Meissner, G. (2005). Credit derivatives: application, pricing, and risk management. New Jersey: John Wiley and Sons Read More