Six Questions: The Alphabet Soup of Market News

Need help decoding the strings of letters you hear in the financial media? Start here.
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In mid-May,

Federal Reserve

chairman Ben Bernanke moved the markets by discussing the condition of "TAF auctions." A day later, investors were rattled by an announcement that related to something named "Ofheo" (or "OFHEO").

What these developments mean to stock market participants -- besides the need to pay attention to the news -- is that arcane abbreviations and acronyms are now permanent fixtures in the investment milieu.

So here is a six-question investment quiz to test -- and possibly enhance -- your knowledge of the alphabet soup that has been regularly served up with your investment news.

Feel free to use the many features available on

TheStreet.com

to help you answer the questions. A great place to start your quest is the "Search" box at the top of

TheStreet.com

.

Another great resource available on our Website is a glossary of financial and investment terms. Just roll-over the "Portfolio Tools" tab at the top of the site and select the "Glossary" option (or simply

click here

).

This is a self-test, so keep your own score. Ready?

Good luck!

Question 1:

What are the "TAF auctions" that Bernanke talked about?

If the head of the Federal Reserve focuses on a subject in a major presentation, it is something investors should be familiar with.

Question 2:

What is Ofheo?

Related question: What are GSEs?

These represent subjects that are of concern to Americans in areas well beyond the realm of

securities investments. Financial institutions around the world feel the impact of these harmless looking strings of letters.

Hint: Ofheo -- no relative to Shakespeare's Othello -- involves extremely large amounts of money.

Question 3:

What do MBS, CMBS and RMBS stand for? And how are they all related?

You won't fully understand the underpinnings of the current financial imbroglio without an understanding of these terms.

Hint: They do not stand for mambos, carambas and rumbas.

Question 4:

What do CDO and CDS stand for?

Other abbreviations will come and go, but these are likely to part of the investment scene for some time to come. So it is especially important to be familiar with these terms.

Question 5:

What are SIVs and what was their part in the credit crunch?

Some observers have accurately referred to SIVs as "sieves" for a very good reason. Can you explain why?

Question 6:

What does ABS stand for?

This term that is virtually certain to be part of the financial vocabulary long after the 2007-08 (or possibly 2007-09) credit crunch drops from the news.

Hint: It does not stand for antilock braking system, nor is it an abbreviation for absent, absolute or abstract -- although some feel that it is

absolutely

certain that considerable wealth is now

absent

because of these

abstract

financial constructs.

Ready for the answers?

Answer to Question 1:

TAF stands for the Federal Reserve's "Term Auction Facility," a program started in 2007 in response to the credit crunch. Its purpose is to add

liquidity to the recently troubled financial markets. The program allows banks to acquire funds at rates as low as 3% for periods of usually four to five weeks. The Fed credit is in exchange for collateral that the

central bank has traditionally not readily accepted. These might involve mortgage-backed securities (the answer to question three) with liquidity issues that would otherwise make them difficult to accurately value.

Answer to Question 2:

Ofheo -- the Office of Federal Housing Enterprise Oversight -- is the government agency with oversight over the

Federal National Mortgage Association

(

Fannie Mae

(FNM)

) and the

Federal Home Loan Mortgage Corp.

(

Freddie Mac

(FRE)

). As such, Ofheo plays a crucial role in U.S. home financing. The current credit crunch, which was triggered by abuses in the sub-prime mortgage infrastructure, has elevated the importance of Ofheo.

Ofheo also publishes information about housing and mortgages. For example, on May 22 it reported that U.S. home prices fell a seasonally adjusted 1.7% during the first quarter of 2008.

GSE stands for Government Sponsored Enterprise, which is a financial services organization created by the government to help finance farmers, students and homeowners. Fannie Mae and Freddie Mac are publicly chartered GSEs that are investor-owned. Their

equity and

debt securities are not guaranteed by the government, although their debt securities are frequently referred to as "implicitly" backed by Uncle Sam.

Answer to Question 3:

MBS stands for mortgage-backed securities, which are asset-backed securities that have been secured by the "packaging" of mortgages. Uncertainty over mortgage-backed securities containing subprime mortgages triggered the current credit crunch.

CMBS stands for commercial mortgage-backed securities, which are backed by mortgages on commercial properties, such as office buildings and retail developments. These have tended to prove more stable than the RMBS (residential mortgage-backed securities) market, which contains securities backed by mortgages on homes.

RMBS stands for residential mortgage backed securities. With home mortgages as their base, many of which were subprime, these were at the root of the credit crunch.

Answer to Question 4:

CDO stands for collateralized debt obligation, a security backed by a "package" of collateralized assets, such as

corporate bonds or mortgages. The size of the CDO market has been estimated to be close to $2 trillion.

If the collapse in value of CDOs backed by subprime mortgages helped trigger the credit crunch, then ownership of CDS (credit default swap)

derivatives helped some organizations to survive or even prosper during the maelstrom.

A CDS is essentially an insurance policy against a negative "event" -- such as a default -- in a credit security. A CDS is created by an organization that accepts premiums from another organization based on credit securities that may be issued by a third party.

CDSs can be traded and may be owned by parties that don't own the "insured" securities.

Goldman Sachs

(GS) - Get Report

wisely used CDS positions to immunize the firm from losses resulting during the credit crunch.

Answer to Question 5:

SIVs are structured investment vehicles. These are entities that borrow funds at short-term rates, such as in the

commercial paper market, and use the proceeds to purchase long-term obligations that offer higher yields. They profit from the differences between the short-term and long-term rates. Some major financial institutions, such as

Citigroup

(C) - Get Report

and

HSBC

(HBC)

, set up SIVs as separate entities in order to sidestep regulatory restrictions on borrowing and lending (see "

What You Need to Know About SIVs

"). But to assure investors in the separate entities that they were secure, they frequently guaranteed the SIVs. Then, when SIV holdings in CDOs (see answer to question four) containing subprime mortgages crashed, the big institutions were hammered by losses, thus exacerbating the impact of the credit crunch.

Answer to Question 6:

ABS stands for asset-backed securities. These are debt instruments whose payment streams are backed up by pools of collateralized assets. The asset pools may include, among other things, home equity loans, credit card receivables, student loans, equipment leases and trade receivables. (Home equity loans, by the way, are aptly abbreviated HELs.)

Many of the terms we have covered so far fall into a large category broadly related to ABS. Aggressive use of such investment devices resulted in overuse of subprime mortgages as collateral and, when homeowners started to default in ever larger numbers, the houses of cards collapsed, resulting in the credit crunch, which is still being worked through today.

Richard Widows is a senior financial analyst for TheStreet.com Ratings. Prior to joining TheStreet.com, Widows was senior product manager for quantitative analytics at Thomson Financial. After receiving an M.B.A. from Santa Clara University in California, his career included development of investment information systems at data firms, including the Lipper division of Reuters. His international experience includes assignments in the U.K. and East Asia.