Thursday, October 26, 2006

Risks Increase in Global Financial Markets

A recent CFA publication addresses the risks and rewards implicit in the growth and breadth of global capital markets.

The depth and flexibility of global financial markets has grown significantly by integrating new geographic regions, creating innovation in financial products and attracting new investors. However, these changes in market structure have also increased the potential risk and magnitude of a global financial crisis. As new investment products proliferate, untested market dynamics, market liqudity & the operational infrastructure pose additional risks.

For instance, the leveraged loan market has grown substantially through the use of new instruments such as credit default swaps and collateralized debt obligations and the use of leverage to provide attractive yields. The demand for these products is high, driven by hedge funds and other institutional investors. According to S&P, the demand (liquidity)is driving "loose" underwriting and increasing the risk when the credit cycle turns.

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