Question

I was looking for help with an exercise. I'm currently solving a case centered around a firm's very controversial and unethical involvement in a mortgage-backed securities deal in 2006. After the reveal of such an incident, the market value of the company's common stock fell overnight by $10 billion which was far more severe than any fine that might have been imposed. How do I explain this? Is it simply because of investors' overreaction to bad news or are there any other factors in the mix? Thanks in advance

Answer 1

The stock price at any point in time, is an outcome of interplay of numerous qualitative and quantitative factors. Hence, any sharp decline or increase in the stock price is very complex and difficult to justify.

However, in this particular case, the sharp decline was due to weakening of the investors'sentiments. The decline was on account of:

• Sudden realization that company had been involved in MBS deal
• The quantum of exposure was very high, there was potential probability that the company might have gone down the drain
• The realization of the fact that the losses were imminent and could not be avoided
• The magnitude of the losses
• The enormity of the problem in hand - the quality of the MBS
• The contagious effect - that entire economy will be pushed into recession
• The fact that company might not be able to stand again on its feet

The sharp decline was mostly led by:

• Magnitude of the problem
• Enormity of the complexity involved
• Potential losses
• Sudden realization

All these factors weaken the investor's sentiment so much, that the stock went into a downward spiral. It defied gravity to fall into a blackhole.