1-Explore one (1) financial market and the types of transactions supported by it in the U.S. and global economies. Determine how valuable these transactions are to the overall U.S. and the global economies.
The market, which is going to be explored is “Bond Market.” A bond is a type of debt investment by which the debtors lend their money, to agencies, i.e., municipal, governmental and corporate. These entities borrow funds for a defined period with the agreement of paying it with agreed interest. The present value of the cash flows (interest payments) and the principal amount at maturity is the price of the bond. The interest payment is represented as a portion of the Bond FV. The interest rate can change or remain fixed over the period, as per the type of bond. Short-term bonds usually have the life of one year to five years, whereas long-term bonds can have the maturity of twelve to thirty years. Convertible bonds are another type of bonds, which can be assigned to the stock by the bondholder at a specific price.
The bond market is of importance to any economy. US economy, its importance can be assessed by the volume of trading in it. About two-thirds of the debt market trading volume is seen in the bond market. Furthermore, the interest rates are affected by the bonds in the US economy. It subsequently affects the amount of liquidity and acts as a deciding factor for ease or difficulty in loan taking. Taking on houses, educations, cars, and expansion of business are all done majorly through loans. How much expensive these loans would depend on the interest rates (ICMAgroup.com, 2013).
2-Evaluate all the factors that affect interest rates to determine the one that appears to impact interest rates the most in today’s economic climate. Support your answer with evidence and examples.
There can be many underlying economic forces which cause a change in the interest rates. The change in the availability or demand of the loanable funds can impact the interest rate change. Any changes in the availability or demand of loanable funds are affected by many factors. Changes in the economic growth are one of these factors. When business is expecting improved economic conditions, they tend to explore more options for expansion, more investments which mean increased demand for loans. It shifts the demand curve and moves the equilibrium point, i.e., interest rate higher. Similarly, any change in the supply curve, for example by the upward shift in wages and savings would affect the interest rate as well. The inflation rate is another factor which can affect the amount of spending by the businesses and the households. It is to be noted that a decision to spend affect the amount saved, i.e., supply, and the amount borrowed, i.e., demand of funds.
Example of this can be an expected interest rate incremental in the US can cause the businesses to save less and spend more before prices rise. Furthermore, it would also trigger more borrowing for more spending affecting the demand curve as well. It will together cause an increase in the interest rate. Another factor is the monetary policy of an economy. The federal can increase and decrease the supply of funds through changing the total amount of deposits held by the banks. The increase in supply lowers the interest rates. The credit crisis of 2008 is a perfect example. From 2000 to 2003, reduced demand caused lowered interest rates. From 2005-2007, economic growth of US increased the interest rates. In 2008, credit crisis lowered the interest rates. The budget deficit and huge spending by US government caused interest rates to rise, but at the same time the businesses canceled out their plans for expansion decreasing the interest rates. The Fed increased the fund supply to increase the loanable funds available for the businesses and households in the weakened economy. This policy remained for a further four years. US economy in this period and currently is shown to be affected majorly by the monetary policy than any other factor (Madura, 2014).
3-Analyze the ease or difficulty of forecasting interest rate changes. Assess the value the forecast provides.
The forecasting interest rate is best forecasted when an equilibrium state is established, and the affecting factors are best known. The past fluctuations can also help in forecasting of future interest rates. The demand of the future loanable funds regarding government demand, household demand, and business demand is considered. The household demand is assessed by the borrowing capacity of the household. The earning power of the households would determine their ability to supply loanable funds. The future expansion plans and state of the economy would be assessed to determine the demand by corporate. The future state of the economy determines the federal demand as well. The Fed’s public statements can be assessed for this purpose. But mostly it is not easy to evaluate these statements.
Net Demand=Demand A-Supply A
=(Demand h+Demandb+Demandm+Demandf)-(Supplyh+Supplyb+Supplyg+Supplym+Supplyf)
The positive net demand as per this equation shows that the interest rates will rise. A negative net demand would mean that interest rates would decrease (Madura, 2014). The current US interest rate is 1.4% at the end of 2017. It has forecasted to increase it in 2018 to 2.1%. The forecast is expected to show economic progression (Fred, 2017).
4-Examine why the Federal Reserve was created. Then construct an argument as to whether or not the Federal Reserve’s major roles are essential to the U.S. economy.
The Federal Reserve is the central bank of the United States. Congress created it in 1913 to give the people with a stable financial system. The Federal Reserve is designated to perform responsibilities which can be categorized into four areas. First one is the operation of the monetary policy with the aim of better employment and stable prices through influencing the credit and money markets. Secondly, it is responsible for supervising and regulating all the commercial and noncommercial banks and other financial institutions for soundness and safety of the national financial and banking system it is responsible for safeguarding the credit rights.
Furthermore, the Fed is also responsible for maintaining stable operations of the financial system and systematic risk of the financial markets. Another major responsibility of Fed is to provide its services to the USA government, and it’s all national and foreign financial institutions. It is liable to oversee and operate the national payment systems (Federal Reserve System, 2017). The role of the Federal Reserve was designated to it after much turmoil and banking crisis. It is not that there has not been any financial crisis after the creation of Fed, but it is evident that these crises were better managed due to the better monetary policies of the Fed and its role in it (Bordo, 2013).
5-Choose a recent monetary policy (adopted during the past twelve (12) months). Analyze its current and future impact on the U.S. and global economies.
Fed aims to maximize the employment rate, stable the prices as well as interest rates. The assessment of the monetary policy of the Federal Reserve in the future year shows that it has targeted an inflation rate of 2% to stabilize the prices. The Fed influences the money supply and credit conditions by setting a target fed funds rate. It is the borrowing rate of the banks and lends reserves in the night. Starting from 2007, Fed decreased the rate from 5.2% to 0.2% in Dec 2008. It is usually low for a long time for the aim of compensating the effect of the financial crisis. Since Dec 2015, Fed has raised the interest rate and is expected to raise it more. The increase in interest rate would affect the interest-sensitive spending in the US market.
Also, it affects the capital flows between countries affecting the exchange rate, subsequently affecting the export and import spending. After the Fed lowering the Fed Funds rate also provided additional stimulus for growth through the buying of securities. It is known as quantitative easing. From 2009 to 2014, three times QE was done. At the last purchase, the balance sheet of Fed was over $4 Trillion, five times greater. The balance sheet has been maintained since to 2017 and reduces its size gradually over time.
The interest rates are increased by Fed through raising the interest rate paid to banks on the reserves and through reverse repurchase agreements. Fed expects that it will gradually increase its Fed fund rate; however, it is expected to remain same with current conditions. The employment as per Fed has maximized, but the inflation rate is lower than 2%. If Fed increases the rates too quickly, then it can also cause financial instability, while some think it will cause the inflation to stay low and obstruct the expansion (Labonte, 2018).
6-Imagine you are a financial manager. Develop a strategy for the use of bond markets by either an investor or firm of your choice to meet a stated financial objective of your choice for that investor or firm.
The objective set is to expand the company by the diversification of its business activities including the manufacturing of electronics. For the attainment of this objective, the company is needed to raise funds, and the bond market is suggested to be used for this purpose. As a financial manager, the best strategy would be to set an objective and targeted return from the expanding business. The expansion through new plant of manufacturing is needed to be funded by the bond market. The location or the plant is set to be in Georgia. A minimum capital of USD 10 million is expected to be raised. To raise this amount of capital, 10,000 bonds with a face value of $1000 would be needed. Coupons are to get at 2.5, 3.5, and 6%. These would be for 5, 10, and 20 years. The reputation and creditworthiness of the company have never been questioned, and hence repayment of the bond is assured.
References
Bordo, M. D. (2013). The Federal Reserve’s Role Actions Before, During, and After the 2008 Panic in the Historical Context of the Great Contraction. Retrieved from https://www.hoover.org/sites/default/files/across-the-great-divide-ch6.pdf
Federal Reserve System. (2017, December). What is the purpose of the Federal Reserve System? Retrieved from https://www.federalreserve.gov/faqs/about_12594.htm
Fred. (2017, December 13). FOMC Summary of Economic Projections for the Fed Funds Rate, Median. Retrieved from https://fred.stlouisfed.org/series/FEDTARMD
ICMAgroup.com. (2013, March). Economic Importance of the Corporate Bond Markets. Retrieved from https://www.icmagroup.org/assets/…/Corporate-Bond-Markets-March-2013.pdf
Labonte, M. (2018, January 9). Monetary Policy and the Federal Reserve: Current Policy and Conditions. Retrieved from https://fas.org/sgp/crs/misc/RL30354.pdf
Madura, J. (2014). Financial Markets and Institutions. Cengage Learning.
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