The 2007-2008 Financial Crisis

The 2007-2008 Financial Crisis

Financial instruments are legal agreements that require one party to pay money or something of value or to promise to pay under specified conditions to a another party in exchange for the payment of interest or the acquisition rights for premiums, or for protection against risk. In exchange for the payment of the money, the counter party hopes to profit by receiving interest, capital gains, premiums or protection for a loss (Geek, 2012). Financial instruments such as, saving deposits, bonds, and CD's are examples of some financial instruments. The financial instruments that are more difficult to decipher and are some of the contributors to the financial meltdown in 2007-2008 are:

* Sub-Prime Loans- "loans that are offered at a rate above prime to individuals who do not qualify for prime rate loans. Subprime borrowers are often turned away from traditional lenders because of their low credit ratings or other factors that suggest that they have a reasonable chance of defaulting on the debt repayment (Investopedia, 2012).

* Collateral debt Obligations (CDO's) - "A type of collateralized debt obligation (CDO) that a dealer creates for a specific group of investors. The CDO is structured according to the investors' needs. The investor group then typically buys a single tranche of the bespoke CDO. The remaining tranches are then held by the dealer, who will usually attempt to hedge against losses" (Investopedia, 2012).

* Asset-back commercial paper (ABC Paper) - "is a form of commercial paper that is collateralized by other financial assets" (Investopedia, 2012).

* Structural investment vehicles (SIV's)- "The strategy of SIVs was to borrow money by issuing short-term securities, such as commercial paper and medium term notes and public bonds at low interest rates and then lend that money by buying longer term securities at higher interest rates, with the difference in rates going to investors as profit" (Investopedia, 2012).

* Synthetic CDO's - "a complex financial security used to speculate or manage the risk that an obligation will not be paid. It is a derivative, meaning its value is derived from events related to a defined set of reference securities that may or may not be owned by the parties involved" (Investopedia, 2012).

* Credit default Swaps (CDS's) - "an agreement that the seller of the CDS will compensate the buyer in the event of a loan default. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults" (Investopedia, 2012).

Financial Instruments can be categorized according to whether they are securities, derivatives of other instruments or so called cash securities. They can be categorized by asset class depending on whether they are equity based or debt based. If it is a debt security, it can be further categorized into short term or long term. The complexity of financial instruments is an issue that needs to be resolved. The above financial instruments were used in bundled packages that did not provide adequate security and interest and payment terms that many borrowers failed to meet once the market interest rates raised sharply (Business, 2011).

Derivative instruments classification would include such instruments as futures, options, and swaps. Some analysts also prefer to include stocks, bonds, and currency futures within this category as well, while others tend to think of these instruments as cash equivalents, since it is possible to