Saturday, August 18, 2007

Subprime loans and Hedge funds

With the debacle of U.S subprime mortgage loans looming large over the Indian bourses and causing substantial negative impact in the Indian markets, a lot of investors are looking at hedge funds for an escape. Now for all the amateurs, here is an explanation on the U.S subprime mortgage loans and hedge funds.

What is subprime mortgage loan ?

There are 2 kinds of loans in U.S, they are the Prime and Subprime loans both are handled by private banking sectors in U.S.

Lets just focus on subprime loans for the moment.

The Subprime loans are the loans given to people with poor credit history. A lot of private banks in U.S had given a huge amount of subprime loans (the total amount is still not known) for the housing sector on instructions from the U.S government for reasons best known to them.

So what the hell is the problem ?

The history has repeated itself and a large number of debtors have defaulted in their repayments resulting in a large liquidity crisis for the U.S banks.

Why should this affect the Indian bourses and other global bourses?

Thats the beauty of 'Macroeconomics', ours not an independent economy and is dependent on the economies of a lot more countries other than India but primarily dependent on economy of the U.S. The magnitude of the dependence may vary from one country to another and impact of the dependence will vary accordingly.

Now coming back to the question as to why the U.S subprime crisis should affect the Indian bourses is because the FII's (Foreign Institutional Investors) who are mostly private banks from U.S have invested a huge amount of money in Indian and other global markets and have set themselves in a selling spree to increase their liquidity. This resulted in roughly about 2,00,000 crores of money being washed away from the Indian bourses. Though it constitutes only about 5 to 6 % of the total market capitalisation of the Indian bourses, it still is some big money.

The figures given below will show you the impact of the U.S subprime crisis in Indian markets.

On the start of Aug 1st 2007, the SENSEX was hovering around 15550.99 points and today Aug 17th 2007, the SENSEX has plummeted to 14131.84 points, thats a fall of about 1370 points and roughly about 8.8 % fall in 12 trading sessions swiping away more than 2000 billion crores from the Indian markets.

Alright we are definitely headed a downhill movement in Indian markets but why does Hedge Funds come into play ?

Hedge funds are private investment vehicles that are not regulated but are known to perform well when the markets are set for a steep fall or a steep rise like it is at the moment. They take big bets on a wide range of assets and specialise in sophisticated investment techniques.

Who runs them ?

Hedge funds are run by former bankers or traditional investment managers who set up their own funds. They are known to make a lot of money by their sophisticated investment techniques and charge roughly about 2 % for management fees and 20 % on profit.

Does hedge funds incur a loss ?

Yes, some of the hedge funds have incurred a big loss by betting the wrong way on recent market movements. A few of them have made losses by buying complex packages of debt that contain many of the U.S mortgage loans that are now turning sour. There are no regulators to bail you out in case of crisis and the full blow is apon the investors if the fund goes bust but then again the higher the risk the higher will be the return and its always been the case with the stock markets.

How big are the hedge funds ?

There are thousands of hedge funds in existence accounting for trillions of dollars of investments worldwide. They have enjoyed a surge in popularity in recent years as investors have tried to diversify their assets and increase their returns.

Hope a bit of enlightenment helped you.

1 comment:

optimismattheheights said...

recommenting of sorts.. This was the first blog of urs i read..