Final Report IB&SA

7/31/2019 Final Report IB&SA

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STOCK MARKET CRASHESInvestment Banking & Security Analysis

Submitted to:

Sir Fawad Fazal

Submitted by:

Zarish Safdar (6939)

Muhammad Ahsan Khanzada (7710)


2/19

Institute of Business Management Page 2

LETTER OF ACKNOWLEDGEMENT

Institute of Business Management

Korangi Creek, Karachi-75190, Pakistan

UAN (9221)111-002-004, Fax: (9221) 509-0968

Http://www.iobm.edu.pk

December 31, 2011

Firstly we would like to thank our instructors Mr. Fawad Fazal for molding our thoughts

intellectually and spiritually. Our instructor guided and helped us with her professional

skills at every stage of making the report and it is an honor being blessed with such

instructor. He was a great source of inspiration in our work.

An effort has been made to the utmost level in this report to cover the most important

pointers that we have learnt from this course.

And we have tried our level best to come up to all of your expectations and this will be

proved from our report.

Sincerely yours,

Zarish Safdar (6939)

Muhammad Ahsan Khanzada (7710)
http://www.iobm.edu.pk/http://www.iobm.edu.pk/http://www.iobm.edu.pk/


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LETTER OF TRANSMITTAL


Korangi Creek, Karachi-75190, Pakistan

UAN (9221)111-002-004, Fax: (9221) 509-0968

Http://www.iobm.edu.pk

December 31, 2011

Sir Fawad Fazal

Lecturer, Finance Department


Karachi.

Dear Sir,

The reports topic was Stock Market Crashes. The main objective of this report was to find

out the common and exclusive points between the four well known stock market crashes

and lessons learned from these historic crises.

If you have any queries or doubts about the compilation of this report you may

feel free to contact us at the emails below.

Sincerely,

Ahsan Khanzada ([email protected])

Zarish Safdar ([email protected])
http://www.iobm.edu.pk/http://www.iobm.edu.pk/mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]://www.iobm.edu.pk/


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TABLE OF CONTENTS

STOCK MARKET CRASH ............................................................................................... 5DILEMMA FACED BY INVESTORS ............................................................................. 5

CRASH OF 1929 ................................................................................................................. 6

EXCLUSIVITY ...................................................................................................................... 8

CRASH OF 19731974 ....................................................................................................... 9

EXCLUSIVITY ...................................................................................................................... 9

CRASH OF 1987 ............................................................................................................... 10

EXCLUSIVITY .................................................................................................................... 11CRASH OF 2007-2009 ...................................................................................................... 12

EXCLUSIVITY .................................................................................................................... 14

COMMONALITIES BETWEEN THE FOUR CRASHES .......................................... 15

LESSONS LEARNED FROM THE CRISES ................................................................ 16

CONCLUSION .................................................................................................................. 19


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STOCK MARKET CRASH

Stock Market Crash refers to a rapid and often unanticipated drop in stock prices. A stockmarket crash can be the result of major catastrophic events, economic crisis or the collapseof a long-term speculative bubble. Well-known U.S. stock market crashes include the

market crash of 1929 and Black Monday (1987). Stock market crashes wipe out equity-investment values and are most harmful to those who rely on investment returns forretirement. Although the collapse of equity prices can occur over a day or a year, crashesare often followed by a recession or depression.

DILEMMA FACED BY INVESTORS

Over the last hundred years, there have been several large stock market crashes that haveplagued the American financial system. For example, during the Great Depression, stockprices dropped to 10% of their previous highs and during the crash of 1987, the market fell

more than 20% in one day.

Due to the way stocks are traded, investors can lose quite a bit of money if they don'tunderstand how fluctuating share prices affect their wealth. In the simplest sense, investorsbuy shares at a certain price and can then sell the shares to realize capital gains. However,if the share price drops dramatically, the investor will not realize a gain; in fact, theinvestor will lose money. For example, suppose that an investor buys 1,000 shares in acompany for a total of $1,000. Due to a stock market crash, the price of the shares drops75%. As a result, the investor's position falls from 1,000 shares worth $1,000 to 1,000shares worth $250. In this case, if the investor sells the position, he or she will incur a net

loss of $750.

Another way that an investor can lose large amounts of money as a result of a stock marketcrash is by buying on margin. In this investment strategy, investors borrow money in orderto make a profit. More specifically, an investor pools his or her own money along with avery large amount of borrowed money in order to make a profit on small gains in the stockmarket. Once the investor sells the position and repays the loan and interest, a small profitwill remain.

For example, if an investor borrows $999 from the bank (at 5% interest) and thencombines it with $1 of his or her own savings, that investor will have $1,000 available forinvestment purposes. If that money is invested in a stock that yields a 6% return, theinvestor will receive a total of $1,060. After returning the loan (with interest), about $11will be left over as profit. Based on the investor's personal investment of $1, this wouldrepresent a return of more than 1000%.
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This strategy certainly works if the market goes up, but if the market crashes, the investorwill be in a lot of trouble. For example, if the value of the $1,000 investment drops to$100, the investor will not only loses the dollar he or she contributed personally, but willalso owe more than $950 to the bank (that's $950 owed on an initial amount of only $1provided by the investor).

In the events leading up to the Great Depression, many investors used very large marginpositions in order to take advantage of this strategy. However, when the depression hit,these investors worsened their overall financial situations, because not only did they loseeverything they owned, they also owed large amounts of money. Because lendinginstitutions could not get any money back from investors, many banks had to declarebankruptcy. In order to prevent such events from occurring again, the Securities andExchange Commission made regulations that prevent investors from taking large positionson margin.

CRASH OF 1929

The stock market crash of October 1929 is often seen as the end of the prosperity of the1920s. However, there were many signs that the economy was already on the way downbefore the crash. The two worst days were October 24, 1929 (Black Thursday), and

October 29, 1929 (Black Tuesday).

Stock prices increased dramatically in 1928, with the Dow Jones Industrial Averagereaching a peak of 381.2 on September 3. Stock prices fell by about 10 percent followingthis peak, but then rose again by about 8 percent by mid-October. Panic selling appears tohave set in on October 23, and on October 24 a record-breaking 13 million shares weretraded, compared to an average of 4 million shares per day in September.

The technology of the day (telephone and telegraph lines) was not able to keep up with thetrading, and the ticker tape ran an hour and a half late. Many sellers did not learn of theprices they received for their trades until later that night. Several of the nation's largestbankers were alerted to the crisis and announced that they were willing to buy stocks abovethe going prices.
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The intent of the bankers was to give people confidence in the market and thus preventpanic selling. On October 25, President Hoover also tried to halt the panic selling byreassuring people that the fundamental business of the country that is, the productionand distribution of goods and servicesis on a sound and prosperous basis.

Although prices steadied for a few days, panic selling started again on October 28. Nearly16.5 million shares were traded on October 29, and the downward trend in stock pricescontinued. Two weeks after the crash, the average prices of leading stocks were about halfof what they had been in September.

After the stock market crash of 1929, things only got worse. By the end of 1929 the marketrecovered somewhat, but in general stock prices continued in a downward spiral until1932. By 1932 average stock prices had fallen more than 75 percent, people had lost anestimated $45 billion in wealth and the market did not reach its 1929 peak level for another25 years.

Economists generally do not view the crash of 1929 as a cause of the Great Depression, butthey agree that the fall in stock prices made the situation worse. The optimism and hope ofthe 1920s gave way to feelings of skepticism and uncertainty. Consumers and businesseswere less willing and less able to spend money, given their losses and their lack ofconfidence in the economy. Banks lost vast amounts in the crash also, and did not have theliquidity they needed to make loans to tide people over until the market recovered.

Many banks subsequently failed. The resulting decrease in consumption and investmentspending, and an increased desire to hold cash balances outside the banking system, led toa downward spiral of declining production, increased unemployment and falling prices.The crash on Wall Street also led to stock market crashes around the world: first inLondon, then in Paris, Berlin and Tokyo. Several reforms were implemented after thecrash, intended to prevent further stock market crashes.

The Glass-Steagall Act of 1933 prohibited banks that are members of the Federal Reservefrom affiliating with companies whose major purpose is to sell stocks. The SecuritiesExchange Act of 1934 established the Securities and Exchange Commission (SEC) toprotect the public against misconduct in the securities and financial markets. This act alsorequired the Federal Reserve to regulate margin requirements in order to reducespeculation.


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Exclusivity

Many economists believe that Federal Reserve policies led to the stock market crash of1929 and were a main cause of the Great Depression that followed. Prior to the stockmarket crash, in 1928, the Fed decreased the money supply in the economy in part to try todiscourage stock market speculation. This tight monetary policy probably contributed tofalling stock prices in 1929, because it made it more difficult for people to borrow moneyto buy stocks. Economists disagree about the causes of the stock market crash of 1929.They agree, however, that there was no single, dominant cause, and that many factorsworked together to bring the market down. Here are some of the exclusive reasons for1929 crash:

1) Federal Reserve policies: The tight monetary policy of the Federal Reserve priorto the crash may have led to the crash. The Fed caused interest rates to rise becauseit wanted to curb speculation in the stock market late in the1920s. This may haveled to a decrease in demand for stocks and falling prices.

2) The Smoot Hawley Tariff Act: This act, meant to stimulate U.S. production,would impose high tariffs on imports. Investors were concerned that if it passed (itdid pass in 1930), the profits of exporting companies would fall and other countrieswould retaliate by refusing to buy U.S. goods. This expectation of lower profits inthe exporting sector may have caused people to sell their stocks.


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CRASH OF 19731974

The 19731974 was a stock market crash that lasted between January 1973 and December

1974. Affecting all the major stock markets in the world, particularly the United Kingdom,

it was one of the worst stock market downturns in modern history. The crash came afterthe collapse of The Breton Woods system United States dollar devaluation under the

Smithsonian Agreement. It was compounded by the outbreak of the 1973 oil crisis in

October of that year.

It had the worst effect in the United Kingdom, and particularly on the London Stock

Exchange FT 30, which lost 73% of its value during the crash. From a position of 5.1%

real GDP growth in 1972, the UK went into recession in 1974, with GDP falling by 1.1%.

At the time, property market was going through a major crisis, and a secondary banking

crisis forced the Bank of England to bail out a number of lenders. In the United Kingdom,the crash ended after the rent freeze was lifted on 19 December 1974, allowing a

readjustment of property prices; over the following year, stock prices rose by 150%.

However, unlike in the United States, inflation continued to rise, to 25% in 1975, giving

way to the era of stagflation.

Exclusivity

1) This crash was unique in a sense that it was not because of speculative hike inprices but had some very different incidents; like oil crises, real estate issues.

2) Overall stocks went down by 73% and by December 1975 they gained 43%, longterm position may save you from this crash.


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This represented a one-day drop of 22.6 percent in the value of stocks nearly doublesthe one-day loss record set during the crash of 1929. Over 604 million shares were tradedon the New York Stock Exchange alone, shattering previous volume records. Some of thevolume was caused by panic selling, as investors tried to sell before prices fell further.Some of the selling was done automatically by computers programmed to sell if prices fell

below certain levels. Phone networks and computers were jammed for hours because of theunprecedented volume of trades, and many people who tried to trade were unable to do so.Investors lost an estimated $500 billion in share values in that one day. In many ways, thiscrash amounted to the nation's worst financial crisis since the Great Depression. Lossesimmediately affected markets around the world, thanks to electronic links and globalcommunication networks.

Exclusivity

The stock market crash of 1987 was relatively painless largely because the Federal Reservemoved quickly to ease monetary policy and reassure banks. These policies probablyprevented big declines in consumption and investment spending that might otherwise havebeen triggered by the loss of wealth from the crash. The fact that no recession followed thecrash of 1987 is often attributed to the competent actions of the Fed immediately followingthe crash. Here are some of the exclusive reasons for 1987 crash:

1) Federal Reserve policies: The Federal Reserves announcement of an increase inthe discount rate from 5.5 percent to 6 percent on September 4, 1987, wasunnecessary. It may have signaled to people that the Fed thought high inflation wasgoing to return. Investors may have decided to sell their stock because of the Feds

announcement.


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Events reached their climax with the bankruptcy of Lehman Brothers in September 2008,which resulted in a credit freeze that brought the global financial system to the brink ofcomplete collapse.

Unprecedented central bankactions combined with fiscal stimulus (notably in the US and

China) helped ease some of the panic in the market place, but by late winter 2009,widespread rumors surfaced that Citigroup (NYSE:C), Bank of America (NYSE:BAC),and other large banks would have to be nationalized if the global economy was to survive.Fortunately, the aggressive actions by governments around the world eventually helpedavoid financial collapse, but the credit freeze forced the global economy into the worstrecession since WW2.

The credit crisis and accompanying recession caused unprecedented volatility in financialmarkets. Stocks fell 50% or more from their highs through March 2009 before rallyingmore than 50% once the crisis began to ease. In addition to stocks, most fixed incomemarkets also displayed unprecedented volatility, with many corporate bond markets at one

point forecasting bankruptcies at a level not seen since the Great Depression. Oil fell 70%,then doubled as the financial system stabilized.

The events of the housing bubble and credit crisis are likely to resonate with consumersand investors for years to come. In many countries (including the U.S.) consumers remainheavily leveraged and many homeowners are "underwater." As consumers deleverage andrepair their finances, their purchasing patterns will be permanently altered.

Many developed market countries have also seen a substantial deterioration in their fiscalposition. While government actions helped prevent worst-case outcomes from the creditcrisis, large budget deficits now represent a structural problem that may take decades to

solve.

Finally, investors have experienced the most volatile and frightening markets of their life.Positive lessons, such as the importance of diversification and independent analysis can betaken from the crisis, but there are also emotional affects that must be considered. Inparticular, investors must remember that the events of the crisis were unusual and areunlikely to be repeated; while excessive greed in the financial markets is inappropriate, sotoo is excessive fear. Investors that can incorporate the lessons of the credit crisis withouthaving their emotions unduly influenced will be best positioned for future investmentsuccess.
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Exclusivity

1) Asset/Liability Mismatch: An asset/liability mismatch occurs when there is awide differential margin between the duration of a financial institution's loansand investments and its deposits or other funding sources. This factor waspresent in the 2007 collapse of Bear Stearns and the 2008 Lehman Brothersbankruptcy and Goldman Sachs and Morgan Stanley chose to become bank

holding companies. Both of these firms were highly dependent on short-termfinancing to conduct their operations. However, the assets that they held provedto be illiquid during the credit crisis, and were therefore effectively long-term innature. This mismatch between the firms' assets and liabilities directlycontributed to their bankruptcies

2) Excessive Risk: Excessive risk occurred unintentionally; investment banks andother financial institutions that purchased mortgage-backed securities prior tothe 2008 credit crisis believed they were safe. However, when extraordinarilyhigh volatility hit the financial markets in 2007, all of trades began to move inthe same direction, prompting massive losses and fears of a systemic financialcollapse. Excessive leverage also exacerbated the asset/liability mismatch atBear Stearns and Lehman Brothers.
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COMMONALITIES BETWEEN THE FOUR CRASHES

1) Margin buying: People could buy stock by paying as little as 10 percent down onthe purchase price, borrowing the other 90 percent. When stock prices fell, stocks

soon weren't worth enough to enable people to pay back the loans. Peoplescrambled to sell their stocks before prices fell even further. So this borrowingpercentage should decrease to 50 or 60 %. To increase ownership of investor instocks.

2) Psychological reasons: When panic sets in, people may react irrationally. Whenpeople saw others selling, they worried that they should sell too before things gotworse. This panic selling caused prices to fall just what people were hoping toavoid.

3) Inflationary fears: Many investors were concerned that the inflation of the 1970sand early 1980s would return, and inflationary fears cause interest rates to rise. Thelong-term rate on some bonds reached a peak of 10.5 percent on the morning ofOctober 19. This may have caused people to sell stock so that they could invest inbonds and other interest-earning assets instead.

4) Stocks were overvalued: 1974-74 crash can be exception otherwise we have seenthat stocks were overpriced in all three crashes. E.g. from 1926 to 1929 stocks weregone up by over 100% and actual performance of the company not following it.The rise in stock prices in the 1980s was also caused by speculation and investorstrying to find a way to get rich quickly. In October 1987, stock prices were far toohigh compared to their earnings and dividends, so prices were bound to fall at some

point.

5) The general state of the economy: Stock exchange is reflection of economicperformance, in all crashes we have seen that economy has started performing low.Signs of a recession were evident in all of these crashes. Production was falling,prices were falling and personal income was falling. Several prominent publicfigures stated publicly that they thought bad times were ahead. These signs mayhave urged stock sell-offs.


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LESSONS LEARNED FROM THE CRISES

Stock market crash chart is very valuable when you want to see what happened with stockprices during periods of great fear. There were several market crashes in last hundred yearsand decades. It is madness to think that crashes will not come. They will come again and

again.

Therefore we think that passive investors but also active investors and traders could findseveral valuable lessons when looking on stock market crash charts.

1. "This time is different"

It is very common to hear this sentence. Every decade after some strong boom in one ofmore areas of economy you will find people telling such sentence. Do not believe it. It isnot different. History of stock market crashes shows us that some crashes will come again.When you will hear such sentence, evaluate the area of economy to which it is pointed and

then wait for bursting of the bubble.

2. The prices can go only up

It is also not true. What is going up will also go down. It is correct the there are strongmidterm trend moves on the market accompanied by pullbacks. But every trend will finishand change into opposite. There are also times of bear trend on the market.

3. Fear is much stronger emotion then greed

Stock prices move up slowly. But when stock prices change their trend, down moves are

much stronger and price move down much more quickly.

4. Diversification will not help during panic

Panic moves across asset class universe. Do not expect that you will be safe withcommodities when stocks will be in panic selling. There are only few safe heavens andthey are also not working all the time. I would mention US 10year Treasury Bonds orGerman Bunds - i.e. fixed income products issues by governments of USA and Germany.

5. What rise too much up will go down very quickly and a lot

Just check some manias. Internet bubble moved price of NASDAQ index up during 6months in final part of bubble during 1999 - 2000 only to erase these gains in 3 weeks. Thesame happened in 2008 when during 2008 panic SP500 index erased gains of last severalyears.


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6. It can take long time before price will recover to pre-crash levels

Sometimes there is only mini crash which last only few days of weeks and then pricerecovers again within few months.

But it can take years to recover from big crashes and as you can see NASDAQ is stillunder 50% of his peak from 2000 bubble. And it is already more than 10 years (2011).


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CONCLUSION

After studying these four crashes we have conclusion that though many factors are similarbut core reasons were different, in 1929 it was declining retail sales, in 1973-74 it was oilcrises, in 1987 main reason was rise in interest rates along with programmed computer

trading, while in 2007 it was derivatives.

First off, we should point out that most market volatility is our entire fault. In reality,people create most of the risk in the market place by inflating stock prices beyond thevalue of the underlying company. When stocks are flying through the stratosphere likerockets, it is usually a sign of a bubble. That's not to say that stocks cannot legitimatelyenjoy a huge leap in value, but this leap should be justified by the prospects of theunderlying companies, not just by a mass of investors following each other. Theunreasonable belief in the possibility of getting rich quick is the primary reason people getburned by market crashes. Remember that if you put your money into investments thathave a high potential for returns, you must also be willing to bear a high chance of losing it

all.

Another observation we should make is that regardless of our measures to correct theproblems, the time between crashes has decreased. We had centuries between fiascoes,then decades, then years. We cannot say whether this foretells anything dire for the future,but the best thing you can do is keep yourself educated, informed, and well-practiced indoing research.

The bottom line, dont trust others with your finances. Do your own research, become

financially educated, and you will be able to spot hidden opportunities that the vastmajority of others miss out on.

While the historic stock prices have generally show good rates of return, it doesnt take

much to wipe out a whole portfolio. Make sure you know what to look for when you enterthe exciting world of investing.
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