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Page last updated at 07:31 GMT, Tuesday, 16 September 2008 08:31 UK
The language of the credit crunch

An office worker looks at a screen showing trading on the FTSE 100 index
The fallout from Lehman Brothers' failure is incredibly difficult to predict
The global financial markets have taken another hit with top US investment bank Lehman Brothers filing for bankruptcy protection and Merrill Lynch bought out by Bank of America.

But as the dust settles from one of the most turbulent days in modern financial history, the complexities of the developments in the global financial markets start to become apparent.

And the complexity of the markets' turbulence is reflected in the language used to describe it. So what do some of those financial terms mean?

A corrupting influence that may spread into the wider community. In financial terms, this refers to the damage caused by the collapse of certain markets and institutions, whose massive interconnection with other institutions and markets means the ripples of a damaging effect are difficult to predict and could be far greater than initially thought.

Credit derivatives
Many of the problems that led to the credit crunch stem from the creation of credit derivatives, securities which get their cash flow from credit risk. One of kind of credit derivative transfers the risk of a loan or mortgage by creating bonds known as collateralised debt obligations (CDOs). These were put together in such a way as to spread the risk of sub-prime mortgages, but when home-owners began defaulting, the CDOs lost much of their value.

A pedestrian walks near an electric market board in Tokyo
Problems in the US have had knock-on effects around the globe
Put simply, an asset that gets its value from the value of another asset - allowing investors to speculate on the future price of apples without buying any orchards. In the financial markets, derivatives have become fiendishly complicated. What began as speculation on the future price of a commodity became "futures" in almost anything - particularly shares, bonds and currencies. Added to this are "options" where the investor can profit if the future price exceeds their expectations, and "swaps" where floating exchange rates can be swapped for fixed ones. The massive amounts of money invested in hugely complicated derivatives mean the contagion of a financial institution's collapse is even harder to predict.

Hedge fund
These are investment portfolios operated on behalf of a small number of clients (usually under 100) who are assumed to be wealthy and financially savvy enough to accept a much higher level of risk than the average investor. As a result they have the freedom to invest in more speculative assets which they balance (or hedge) with other investments in order to maximise the return at the lowest possible risk. Hedge funds are also highly leveraged, meaning that they borrow massive amounts of money to increase their possible profits and losses.

Investment bank
There are, in general, two kinds of banks - commercial and investment. The commercial kind are those that you see in the High Street, that offer current accounts and mortgages to ordinary people. Investment banks generally deal with companies, governments and super-rich investors, issuing securities such as bonds and stocks. As a result no high street customers will be directly affected by the collapse of investment bank Lehman Brothers - although the economic repercussions will certainly affect millions.

Mortgage-backed securities
A financial asset which gets its cash flow from the payments on a set of mortgages. When these securities include mortgages from the sub-prime sector, the cash flow may become difficult to predict and the security lose value.

The trading floor at the New York Stock Exchange
The collapse of Lehman Brothers led to a 4.5% drop in the Dow Jones
This is the process of pooling loans and other investments to create bonds. A large proportion of all home loans are sold on in this way, but problems were created when high-risk sub-prime loans were re-packaged by massive financial institutions, at supposedly lower risk, before being traded on the financial markets.

Used to describe loans to those people who have poor credit history or cannot prove their incomes. In late 2007, falling house prices rates in the US led to defaults on sub-prime mortgages. As banks rely on repossessions to fund the defaults, the money could not be recouped. These loans had been bundled together with less risky assets in the form of collateralised debt obligations by large financial institutions, and when the sub-prime bubble burst these CDOs dramatically lost value, sending shockwaves through the funds which had invested in them.


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