Volatile Markets: Recap October 2008

Volatile Markets: Recap October 2008

Dynamic Funds Invest with Advice 3 Volatile Markets: Recap  Credit Crunch Timeline  History/Background 1.U.S. Sub-Prime Industry Collapses 2.The ABCP Crisis 3.Effects of the Financial Turmoil 4.The CDS Meltdown 5.The $700 Billion Bailout  What’s Next?

Dynamic Funds Invest with Advice 4 Credit Crunch Timeline U.S. Sub-Prime Mortgage Crisis In 2007, U.S. housing prices began to fall ABCP’s and CDS’s 2007/2008, values of financial instruments linked to the sub-prime market such as ABCP’s and CDS’s began to plummet Write-Downs U.S. financial institutions began to report massive losses and write-downs as the value of ABCP’s and CDO’s fell Freeze-Up of the Credit Markets Access to credit began to shut down. A global freeze in the credit markets followed Crisis of Confidence A crisis of confidence hit all global markets.

Dynamic Funds Invest with Advice 5 1. Sub-prime industry collapse begins 2. Canada’s ABCP market freezes 3. Stocks begin surge on announcement of housing bailout, U.S. Federal Reserve cuts interest rates Financial institutions take losses on sub- prime exposure 5. U.S. banking reserves go negative 7. Commodities sell-off begins 8. U.S. investment banks collapse due to CDS exposure, U.S. government takes control of Fannie Mae, Freddie Mac, AIG 6. Bear Stearns collapses/investor s flood into commodities Credit Crunch Timeline 9. The $700 billion bailout Source: Bloomberg, Private Client Research

Dynamic Funds Invest with Advice 6 1. U.S. Sub-Prime Industry Collapses February/March 2007 Sub-Prime Mortgages What are they?  These are mortgages typically granted to borrowers with poor credit, bankruptcies, high debt to income ratios, etc. They are associated with higher interest rates because there is a greater risk the borrower will default on their mortgage. How do they work?  There are various types of sub-prime mortgages, the most popular of which has been the 2-28 loan. In this type of mortgage, the first number indicates a period of time (in years) where the debtor pays a low (teaser) interest rate and the second number indicates the balance of the loan which is carried out at a much higher rate.

Dynamic Funds Invest with Advice 7 1. U.S. Sub-Prime Industry Collapses February/March 2007 Sub-Prime Mortgages: What was the problem?  From the number of sub-prime mortgages in the U.S. was approximately 21% of the mortgage market representing approximately $600 billion.  In 2006 a number of borrowers began to default on their sub-prime mortgages causing many sub-prime mortgage companies to fail as they were unable to cover the losses. But the crisis did not end there.  Many of these mortgages had originally been repackaged in financial products and sold off to various investors around the world making the defaults on the loans a global phenomenon and shaking investor confidence in the entire $7.1 trillion U.S. housing market.  The stock market reacted with fear as investors were unsure what kind of exposure various companies had to the sub-prime market.

Dynamic Funds Invest with Advice 8 1. U.S. Sub-Prime Industry Collapses February/March 2007

Dynamic Funds Invest with Advice 9 2. The ABCP Crisis July/August 2007 Asset Backed Commercial Paper (ABCP) What is it?  It’s a form of commercial paper that is secured by some asset such as a business’ future receivables. It is used by businesses for short- term financing needs, providing short-term credit often used for day to day operations. How does it work?  The bank uses an asset provided by the borrowing company to create an ABCP which is used to provide liquidity to the company.  In order for a bank to issue ABCP it first sells assets to a structured investment vehicle (SIV) created by an investment company.  The SIV then issues the ABCP keeping the institution legally separated from the bankruptcy-remote issuer.

Dynamic Funds Invest with Advice The ABCP Crisis July/August 2007 Asset Backed Commercial Paper (ABCP) What was the Problem?  In 2007, many of the assets underpinning ABCP’s began to perform poorly. The result was a lack of demand for the paper and therefore minimal liquidity in the market.  This drove down the prices and forced losses on the companies holding them.  The markets viewed this very unfavorably as illiquid assets on a bank’s balance sheet become liabilities affecting the bank’s ability to lend.

Dynamic Funds Invest with Advice The ABCP Crisis July/August 2007 Asset Cash Securities Investors Bank Conduit/SIV Loan Asset Asset Owner Asset Return

Dynamic Funds Invest with Advice 12 Effects of the Financial Turmoil September August Stocks Begin Surge  The U.S. Fed decided to cut interest rates by 50 bps in September of 2007 following a proposal from President Bush that the U.S. government would help to bailout homeowners.  The 50 point cut would be the first of several cuts over the next year to keep the banks lending and restore investor confidence in the wake of sub-prime and ABCP problems. 4.Banks Take Losses  Although the cuts were initially helpful to the markets, problems resurfaced through October and November as banks began to report losses tied to their exposure to sub-prime mortgages and ABCP. 5.U.S. Banking Reserves Go Negative  By the end of 2007 U.S. banking reserves had moved into negative territory causing a very large sell off in the markets.

Dynamic Funds Invest with Advice 13 Effects of the Financial Turmoil September August Bear Stearns Collapses; Investors Flood Into Commodities  In early 2008 it was well known that many large financial institutions had exposure to “toxic” investments (ABCP, sub-prime mortgages, etc.) but investors did not know the extent of the exposure. As a result, investor confidence declined once again and financial stocks were sold off in favor of commodities. The sell-off led to the eventual collapse and sale of Bear Stearns to JP Morgan. 7.Commodity Sell-off Begins  As the U.S. dollar suffered under the economic turmoil, investors found a safe haven in gold, oil and other commodities. But in June of 2008 that safe haven was disrupted by fear of a global economic slowdown as the problems facing the U.S. began to be felt in other parts of the world.

Dynamic Funds Invest with Advice The CDS Meltdown September 2008 Credit Default Swaps (CDS)  What are they?  They are derivative instruments not unlike insurance contracts, designed to cover losses on securities should they occur. Banks typically use CDS instruments as a way to insure mortgages.  How do they work?  The buyer of the CDS pays premiums (just like you would pay on your house or car insurance) with the expectation that if losses occur they will be covered by the party on the other side of the transaction.

Dynamic Funds Invest with Advice The CDS Meltdown September 2008 What was the Problem?  You can be confident when you buy insurance for your house or car because the insurance industry is well regulated; CDS’s are not!  CDS trades are not monitored and as a result when a very large number CDS options held by banks and insurance companies were exercised by defaults in the housing sector, the holders were unable to cover all of the losses (as was the case with AIG).  The unregulated nature of the CDS market also meant that CDS’s could be repackaged and traded - ultimately making it difficult to determine what the underlying risk was at any insurer at any given time. When the risk was unknown, the value was unknown and, therefore, there was no demand for these instruments. With the top banks holding more than $13 trillion dollars in CDS’s.  Ultimately led to large write-downs for some of the world’s most respected banks.

Dynamic Funds Invest with Advice The CDS Meltdown September Party “A” buys insurance from party “B” Payout on default Premium 3. Party “B” accepts the risk for a premium 4. Party “B” sells a piece of the risk to party “C”…Who sells a piece to party “D”…Who sells a piece to party “E”… 1. Home buyer secures a mortgage with party “A”

Dynamic Funds Invest with Advice The $700 Billon Bailout October 2008  The Bailout  What is it?  The U.S. government passed a bill presented by the U.S. Federal Reserve to provide relief to the U.S. stock markets by making available $700 billion dollars to restore liquidity in the financial markets.  How does it work?  This cash injection is designed to take some of the pressure off of the big banks by buying some of the assets that are of unknown value. The U.S. government can hold these assets for a period of time allowing the banks to improve cash available for lending. This buyout aims to free up capital at the large banks to resume lending and re-liquify the markets.

Dynamic Funds Invest with Advice The $700 Billon Bailout October 2008  What is the Problem?  The problem with this bailout is that it has not been able to spur confidence in U.S. investors. Investors are not as concerned with these financial problems now as they are with the condition of the global economy. Investors are also waiting to see what the U.S. government does with the $700 billion dollars now that it has been approved.

Dynamic Funds Invest with Advice 19 What’s Next?  Although investors have become increasingly concerned with the state of their investments over the last while, it is important to remember your long-term investment goals.  Saving for retirement is a long-term process and as an investor you need to remember that, in spite of periods of short-term volatility, the stock market has historically been the best place to get strong returns on your money.  Having a financial plan and seeking the advice of your financial advisor is always the best plan.

Dynamic Funds Invest with Advice 20 Important information This presentation is not to be distributed or reproduced without the consent of Goodman & Company, Investment Counsel. Dynamic Funds  is a division of Goodman & Company, Investment Counsel Ltd. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.