The mortgage-backed securities were discovered held in portfolios in banks and hedged in funds all over the world. This greatly affected the other commercial instruments. The stock in the US fell around 13% in fears of collapse of these banks. Investors soon withdrew their money from these banks which led to liquidity problems for the banks. In three days’ time customers had drawn £2 billion. The crisis spread fast to investment funds and management funds that had been exposed to subprime debt. Most of the funds lost value of their assets e.g. Global Alpha hedge Fund lost 26% value; while others stopped valuing their funds due to complete evaporation of liquidity. With attempts by the Federal Reserve to stem the crisis by imputing more money into lending institutions and with the aim of gaining investor confidence, 2008 saw a complete turn of events. Loss of investor confidence in financial institutions spread to credit markets. A decline by 30% prices of market prices for commercial papers was felt.
Fair value has been defined as that price which would be received to sell an asset or paid to transfer a liability in an orderly transaction between the participants in the market at the measurement date (Laux, 827).
The second level input was for direct or indirect observable market data which could be used to value assets with no observable prices. Market information was used to give the mark-to-model measurements (Healy, 6)
Lastly the third level of inputs that entailed unobservable firm supplied estimates e.g. home price depreciation forecasts, resultant credit loss severity on mortgage related position et cetera (Healy, 7).
The application of the FVA resulted in many financial institutions making huge write downs that eventually led to the subprime crisis. Level 2 and 3 inputs had to thorough explained. The