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Last Updated: Friday, 27 July 2007, 09:46 GMT 10:46 UK
Q&A: World stock market falls
How can you tell the difference between a boom and a bubble?
Stock markets around the world have been falling sharply on fears of rising interest rates and a credit crunch. What is causing the fall, and how will it affect the ordinary individual?

What has been happening to the world's stock markets?

The value of the world's major companies has taken a tumble as the world's stock markets have plunged in the past two days.

The move has wiped billions of dollars off the value of shares owned by individuals and institutions such as pension funds and insurance companies.

The fall started in the US, but then spread first to Europe and then to Asia..

Why are shares falling?

In recent years, stock markets have been boosted by a takeover boom.

Lots of companies have been bought at high prices by private equity firms, who borrowed the money to do so from rich individuals and banks.

This has increased the price of other companies' shares, in the hope that they could be next takeover target.

The banks have been more than willing to lend them to money at low rates - partly because global interest rates have themselves been at historically low levels, but also because they have been able to sell these debts on to others through credit markets.

And the low interest rates, in turn, have led to investors seeking higher returns for their money, further feeding the hunger to finance the loans behind takeover deals, as well as a range of more or less exotic investments.

But now the era of cheap money seems to be coming to a end, as lenders have suddenly realised how risky some of their investments in private equity firms might be.

The result is a rapidly-declining appetite among investors for underwriting this kind of lending - and thus the takeover boom may be coming to an end.

It also means that the banks and other financial institutions could be in trouble as they find themselves carrying much more of the private equity lending on their books than they expected to.

In the US, many such institutions are already exposed to losses on bad mortgage loans that were originally given to people with poor credit histories (so-called "sub-prime" lending).

What is the flight to quality?

When people with money to lend become worried about risks, they tend to put their money in safe investments.

So there has been a rush to invest in government bonds, like US Treasury bonds, and safe currencies, like the yen.

In contrast, people are now demanding much higher interest rates to lend to smaller companies or to the governments in developing countries.

And there is almost no market at the moment for the debt relating to sub-prime mortgages or leveraged buy-outs.

How long will it go on?

Stock market fluctuations are a normal part of stock market activity, and no one can say how far shares could fall or how long the slowdown could go on.

Markets have had quite a sharp rise in the past 18 months, and the current correction may simply return them to the previous level.

Broadly, company profits have been strong, and the world economy seems to be entering a period of revival, especially in Europe and Japan.

However, stock markets look at future expectations, so they may be concerned that corporate profits have already peaked.

And even if stock markets recover, it looks like the re-pricing of risk - making it more expensive to borrow for certain kinds of investments - is here to stay.

And the world's major central banks - with the exception of the US Federal Reserve - look set to continue to raise interest rates to combat inflationary fears.

What will it mean to you?

Many individuals own stocks and shares - around half of all US households, and around one-quarter in the UK.

If the stock market falls continue, they may feel less wealthy - and be less likely to buy goods and services, slowing the economy.

In addition, many pension funds own shares which make up part of their portfolio used to pay people's occupational pensions.

If shares fall, they may have less money to pay future pensions, and employee contributions may have to rise.

Already in both the UK and US many companies have closed company pension schemes to new employees.

Finally, the impact on businesses could be mixed.

Smaller, more risky ventures could find it more difficult to get funding, slowing the pace of innovation.

But big companies might become less vulnerable to takeovers, which could mean fewer job losses and restructuring costs as long as profits keep up.


FTSE 100
23.70 0.44%
19.54 0.34%
Cac 40
14.48 0.38%
Dow Jones
78.53 0.76%
35.31 1.58%
S&P 500
11.22 1.02%
BBC Global 30
20.65 0.36%
Data delayed by at least 15 minutes

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