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Market down again

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The markets for today is down again, although the good thing is that it recovered from a steeper fall in the opening session. I guess that those who went in early shorted the market (selling a share without owning the share) in expectation of a big fall today and bought it back later in the day causing it to rise slightly as bargain hunters moved in too.

The news that is going around the world is suddenly all about this 'sub-prime' and what it means. Basically, what this is about is that there is this group of people with poor credit histories and cannot get a housing loan from financial institution. So some smart people in the financial industry invents a new product called the sub-prime loan where all these people are pooled together collectively in a big loan that other financial institution can get a chunk off. Since this people cannot get a loan otherwise as they are considered a risky prospect to lend money to, this product is basically their last chance. So as in all financial product, high risk equals high returns, so these borrowers pay a high interests for these sub-prime loans.

All else being equal, these collective loan offered to banks with all these risky borrowers will actually lower the risk to the bank than one risky borrower who goes to the bank to ask for a housing loan. The rationale for this is the same as collective investment when you invest in several risky investment product, your risk actually goes down. However, in investment, there are two types of risks. One is systematic risk and the other is unsystematic risk. Diversification only reduces unsystematic risk because proper diversification means that you are invested into different industries and different countries so something that says affect one bank in Singapore does not affect the banks in Hong Kong nor the manufacturing industry but it may affect the other banks in Singapore.

Systematic risk cannot be erased by diversification as it is inherent in the nature of investment. So this is the systematic risk of default that occured in the sub-prime market. Since the housing market is slumping with little demand, the prices are falling and if the borrowers are defaulting, those financial institutions that buys these sub-prime loans will have their money gone as the assets that they pick up will be less as prices are lower because of low demand for housing. Once those financial institutions who buy over these sub-prime loans goes or announces huge losses, the economy will go into a tailspin. So at the moment, the sub-prime market in United States is the focus of the financial industries world wide as it can bring the whole bull market worldwide into a permanent bear market.
The indicators are turning bearish.

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