Energy Sector updates

Crude prices remained near their all time highs. Though, January futures are trading roughly at $1.25 lower than December futures. Thursday had vitnessed a rare fall in the crude prices after US department of energy had unexpected reported built up in oil inventories. Financial analysts across thw world are still of the opinion that oil prices would be in higher zone for some more time. This may result in higher profit for oil companies.

In an important development, Brazil is considering joing OPEC after huge offshore oil reserves have been discovered in Tupi fields.

Meanwhile in a meeting of OPEC foreign, finance and oil ministers no decision on output levels was taken and the matter was left to be decided during Dec. 5 meeting of OPEC oil ministers. Also, impact of the weak US dollar on the prices and OPEC members was not considered.A draft prepared (which is still not officially disclosed) warns that the legislation by consuming countries against the oil producing cartel could harm the future energy security.

All in all, there seems to be no respite from the continually growing prices of crude and allied products.

What next...

So the Fed FOMC announced the cut in Fed fund rate and discount date by 50 bps each, which the market was not expecting. The bold move earned a lot of praise for Mr Bernanke and his colleagues. CNBC said God bless the greatest central bank in the world. Sombody said the FOMC is Friend of Market Committee.

So where will all the roads lead the economy. Will the crisis calm down. Well only the time will tell if the crisis is going to sustain or its going to subside. But for the moment the inflation concerns in US economy are looking down as the numbers of CPI, PPI etc have been lower than expected. But, Bernanke and Paulson have said in their testimony that there is still significant risk to the economy esp to the housing sector. Former chairman Greenspan also said that the recession chances are still at significant levels at 1 in 3.

On the other hand BOE chief Mervyn King is being critised by every one for his U-turn when the bank came to the rescue of Northern Rock Plc. after saying earlier that it won't act to help any financial institution as it would create a moral hazard. Defending his role in front og House of Commons Treasury Committee he said he would have prefered a covert help to the bank, but the rules makes it illegal without letting the general public aware of this. The government has guaranteed the money deposits with the bank. The treasury committee is not looking much satisfied much with the testimony and has ordered an enquiry for the current market crisis and the bank's role in it.

Well, the FOMC action brought a wide smile for stock traders and the equity indices across the world are soaring since then . Our own Nifty and Sensex have seen huge rallies this week.

Bin Laden Trade

Quite unusual. Whats this Mr Laden doing in financial markets!!!

Ok! here is the story. The open interest in September 700 S&P puts reached 116,000 contracts. Now since the current levels of S&P 500 is around 1450-1500 this is deep in themoney contract and has very least probability. The seller of such an put option would benefit if there is a huge market crash of the order of 30-50% within next three-four weeks. The market gurus says such a crash is highly uncertain unless there is a terrorist attack of the 9/11 attack. Hence this is given the name Bin Laden Trade.

The estimates say the potential loss to the seller could be in billions if there is no crash in the market. Now such a large bet by anyone obviously creating panic in the market leading even to rumors of a terrorist attacks before 21st September.

So does that mean there is really going to be a crash??? Does that mean we all are going to die within next four weeks??? A popular theory doing the rounds and explaining the idea behind this is as follows:

Selling of such a contract is actually done to take money from the market, since credit is not readily available in the market. The theory says that such a deep in the money contract trades on very high premium because the probability of happening that is very low. Now suppose a put contract which in 1000 deep in money would fetch the seller an approximately premium of 900. Now for the seller this is like a loan from the market. Assuming the normal condition when market stays where it is, the seller will loose the bet at the expiry of contract and may have to give the buyer an amount 1000 or so. This difference of 100 can be considered as the interest paid for the earlier loan of 900. This sounds too logical for such an occurance.

Will Fed... Won't Fed...

Thats the question participants of financial markets are confused with. The possibility of Fed cutting its target Fed funds rate emerged after Fed unexpectedly slashed down its discount window rates by 50 bps a couple of weeks back. The Fed's FOMC will meet in two weeks time to decide on its new monetary policy.

As per market enthusiasts the reduction is quite certain, as is evident from Fed funds futures prices which have taken into account a full 25 bps cut by september and a 75 bps cut by Dec'07.

However it seems that Fed's Bernanke is in no hurry to act. Last week he had told reporters that he will take every possible measure to calm down the credit crunch situation in markets. the current market turmoil has even forced Presidtn Bush to come up with certain policy changes to extend help to troubled homeowners.

In crude sector the focus seems to be now on Storm Felix after Storm Dean had missed key refinery locations in Gulf of Mexico in US coast. Though Met department has already predicted that the storm is set to miss US refineries in the gulf of Mexico, still crude futures were seen to be puuting up some gain.

When Americans sneeze India catches cold

Article from unknown source:

'When Americans sneeze India catches cold'
The Bombay Stock Exchange Sensitive Index or Sensex as it is more popularly known fell by 643 points today. Various stock market experts have blamed the subprime crisis in the United States. So what is this subprime crisis? And why is it having such a decisive impact on the Indian stock market? To know more read on.

Essentially it all starts with an American wanting a home loan. But there is a slight problem. He doesn't have a great credit rating. So a bank will not give him a home loan. Enter a second American who has a good credit rating and is willing to take on some amount of risk. Given his good credit rating the bank is willing to give him a loan. The bank gives thesecond American a loan at a certain rate of interest.

The second American divides this loan, into a lot of small tranches and gives it out as home loans to lots of other Americans like the first American, who do not have a great credit rating and to whom the bank will not give a home loan.

He gives out a loan at a rate of interest at a higher rate of interest than the rate he has borrowed from the bank. This higher rate is referred to as thesubprime rate and this home loan market is referred to as the subprime home loan market. Also by giving out a home loan to lots of individuals, he ensures, that even if a few of them default, his overall position is not affected much.

The question that crops up here is, if this home loan market is subprime, what is prime? The prime home loan market essentially refers to individuals who have good credit ratings and to whom the banks lend directly.

Now back to the subprime market. The individual giving out loans in the subprime market does not stop here. He does not wait for the principal and the interest on the subprime home loans to be repaid, so that he can repay his loan to the bank, which has given him the loan.

What does he do? He goes ahead and securitises these loans. Securitisation essentially involves, converting these home loans into financial securities, whichpromise to pay a certain rate of interest.

These financial securities are then sold to big institutional investors. And how are these investors repaid? The interest and the principal that is repaid by the subprime borrowers through equated monthlyinstallments is passed onto these institutionalinvestors.

The individual giving out the subprime loans, takes the money that he gets from selling the financialsecurities and passes it on to the bank, he had taken the loan from, thereby repaying the loan. Andeverybody lives happily ever after. Well not really.

The subprime home loans were given out as floating rate home loans. A floating rate home loan as the name suggests is not fixed. As interest rates go up, the interest rate on floating rate home loans also go up. As interest rates to be paid on floating rate home loans go up, the EMIs that need to be paid to service these loans go up as well.

The higher EMIs hit the subprime borrowers hard. A lot of them, given their poor credit rating, defaulted. Once, more and more subprime borrowers starteddefaulting, payments to the institutional investors who had bought the financial securities stopped, leading to huge losses.
Well, that still does not explain, why stock markets in India, fell?

Institutional investors who had invested insecuritised paper from the subprime home loan market, saw their investments turning into losses. Most big investors have a certain fixed proportion of their total investments invested in various parts of the world.

Once investments in the US turned bad, more money had to be invested in the US, to maintain that fixedproportion. In order to invest more money in the US, money had to come in from somewhere.

And this money came in from emerging markets like India, where their investments have been doing well. So these big institutional investors, to make good of their losses on the subprime market, have been selling their investments in India and other emerging markets. Since the amount of selling in the market, far overweighs the amount of buying, the Sensex has been on a falling spree.And that explains the title of this piece 'WhenAmericans sneeze India catches cold'.

Welcome

Hi,

My Name is Nishank Agrawal. Rabs Nieder is my nick name. I am strating this blog to create a picture of world economy. I intend to bring in good articles published elsewhere (in other blogs, research papers, from newswires etc.) and my own commentry about the happenings in Global financial markets and their impact on the economies.

I'd appreciate if readers leave their comments here.