Financial Institutions and Markets - Assignment Example

Financial Institutions and Markets By Name The Name of the Class (Course) Professor (Tutor) The Name of the School (University) Date of Submission The global financial crisis of 2008 culminated in one of the sharpest declines in global economic activities of this century. Most of the developed economies experienced economic turmoil and leading to a sharp decline in global trade, weakened consumer confidence and rapid crashes in the stock markets around the globe. Banks faced a liquidity crisis referred to as a credit crunch while the United States housing market experienced a harsh decline with consumers unable to service their mortgages (Zhu 2012 43). The events marking the financial crisis included the collapse of the Lehman Brothers, the collapse of the United States housing market, the collapse of sub-prime mortgages and ultimately the erosion of confidence in the stock markets. The global financial crisis took place based on a series of events, some dating as far back as a decade before. The Asian Financial crisis in 1997-98, led to the general of large current account surpluses invested offshore to keep the nominal exchange rates in these economies low. With the rising of the NASDAQ, most of these monies were channeled towards the dotcom stocks. The dotcom bubble burst in 2001 and the United States Fed fearing deflation eased monetary policy between 2001 and 2004. The net effect was the boom in the housing sector and the rise of leveraged and loans. At the same time, demand for commodities in China led to the growth of the commodities market. These events created the baseline for the global financial crisis(Zhu 2012 50). The triggers for the financial crisis resulted from supervision and regulatory factors. The regulatory authorities such as the United States Federal Reserve Bank failed to exercise authority and offer guidance to financial institutions leading to excessive risk taking. The Fed practiced loose monetary policy but lacked strict supervisory and regulation towards these policies (Mckibbin & Stoeckel 2010 67). The monetary policies led to serious financial imbalances leading to risks fuelled by macroeconomic factors such as capital flows. In most of the markets, banks begun seeking leverage from wholesale financial markets instead of the deposit markets thereby increasing their roll over risk (Mckibbin & Stoeckel 2010 67). Global imbalances were also responsible for the financial crisis. The pre-crisis period experiences a rise in global imbalances characterized by disparities of current account positions between various countries. Global imbalances reduced interest rates. The existence of the two led to a shortage of safe financial assets and instruments for investors. This in turn led to financial institutions increasing their leverage and expanding their balance sheets. Such risky trends in fact affected the banking sector when the crisis hit as was the case with Lehman Brothers. The collapse of Lehmann brothers spread fear and panic within the financial markets that more institutions would follow leading to Governments taking drastic measures to intervene. The governments bailed out various financial institutions especially in the United States. In Australia, the government took precautionary measures by stating it would guarantee bank deposits and releasing a 10.4 billion dollars economic stimulus package (Walker 2013 56). The United States housing market is connected in many ways to the financial markets. It is used as a measure of growth and wealth, with the United States releasing housing numbers on a monthly basis. The housing market acted as a huge baseline for the financial crisis in a large way. With the accommodative monetary policy exercised by the Federal Reserve Bank, there was a surge in cheap credit. The banks begun issuing mortgages and loans to owners cheaply. These loans were referred to as NINJA loans. With the financial system at the brink of falling, most of the homeowners found they were unable to service their loans. Subsequently, a measure of wealth and assets in the United States eroded many people and this led to panic among banks, who found themselves holding onto land and houses (Walker 2013 67). This crisis manifested itself, sent shocks in banks and financial system around the world, and became the first indicator of the impending collapse. These factors were both the triggers and the structural causes for the global financial crisis. Since the crisis, measures including policies and structural frameworks guard the financial markets from another turmoil. Question 2a) The financial markets play a crucial role in the economy. The financial markets act as the intermediary between the savers in the economy and those who need the financial capital for productive purposes. The financial markets play this role through the provision of liquidity in the economy and through mitigation of the risk characteristics of assets. Most economies comprise of savers and borrowers. Most of the borrowers are investors seeking to engage in productive activities. These activities require long-term capital commitment. The savers being risk averse means they often do not want to commit their savings towards these projects. The financial markets thus provide a platform for pooling together resources and thus channel them towards the projects. They thus act as different form of financing to the borrowers. The financial markets also provide for financial instruments such as equities and bonds easily liquidated to provide purchasing power (Akdogu, Umutlu 2014 52). The financial markets further play the crucial role of mitigation of risk through the diversification of the risks involved in the business. In the mitigation of risks, financial markets work towards lowering the cost of transactions and diversifying the portfolio of investors. They further play this role by ensuring exchange and settling of payments. By minimizing risk, the financial markets act as agents of wealth creation. They also allow for the growth of new opportunities not only in the financial services market but in other sectors of the economy (Akdogu, Umutlu 2014 52). Question 2b) A too big financial sector poses certain dangers to the economy of a country. In such a situation, the financial sector finds itself interwoven and linked to all other sectors of the economy. In some countries such as Malta and Luxembourg, the financial sector was at times 5 times the GDP of the nation. The government through the central banks play the role of the regulatory authority. Such a financial sector regarded to as too big to fail and in times of crisis, the Central Bank needs to bail out the financial sector to protect its economy or guarantee the deposits of the investor’s case point being Australia. In a too big financial sector, the government lacks the capacity to bail the banks out or guarantee the deposits. Another danger in a too big financial sector means the government may not fully engage in its supervisory and regulatory role of the financial sector (Antzoulatos, Panopoulou & Tsoumas 2011 125). The government in a bid to spur growth and increase the wealth of its citizens often fails to reign in on risky trends by the financial sector and thus pose a danger to both the economy and the investors. The incentives include the availability of cheap credit and financial services, thereby providing the economy with the necessary capital to enable nation grow its economy and wealth. The big financial services also allow liberalization of the markets and overall growth. The net effect is more taxes for the government and increased employment opportunities (Antzoulatos, Panopoulou & Tsoumas 2011 125). 3. How much financing Commonwealth Bank will raise PV= FV/ (1+K) ^n The cash flow from each year, in the five years: Year 1= $ 60 Year 2= $60 Year 3= $60 Year 4= $60 Year 5 = $1060. The present value, Year 1 = $60/ (1.04) to the 1st power = $57.69 Year 2 = $60/ (1.04) to the 2nd power = $53.41 Year 3 = $60/ (1.04) to the 3rd power = $51.51 Year 4 = $60/ (1.04) to the 4th power = $49.26 Year 5 = $1060/ (1.04) to the 5th power = $849.36 The amount of money raised 57.67+53.41+51.51+49.26+849.36 Value= $1061.21 3b Two major factors affect the prices of bonds in any market. They include interest rates and credit ratings. In most instances, when interest rates rise, the prices of bonds fall and the inverse takes place when prices of the bonds rise. Bonds, a unit of loan to a corporation or governments receive fixed rates of payment. Thus when the interest rates rise, the prices of the bonds change too. Credit ratings published by Moody, S&P and Fitch categorize credit risks. The upgrading of commonwealth Bank from AA to AAA means lesser chance of defaulting on the bond. If the interest rates remain the same, the total yield from the bond goes down while the price of the bond rises. 3c) Year 1= $ 60 Year 2= $60 Year 3= $60 Year 4= $60 Year 5 = $1060. The present value, Year 1 = $60/ (1.04) to the 1st power = $57.69 Year 2 = $60/ (1.03) to the 2nd power = $53.92 Year 3 = $60/ (1.03) to the 3rd power = $52.45 Year 4 = $60/ (1.03) to the 4th power = $44.37 Year 5 = $1060/ (1.03) to the 5th power = $1029.13 The amount of money raised 57.69+53.92+52.45+44.37+1029.13 Value= $1237.56 Question 4 Bills comprise of discount bonds. This implies they sell below par value but mature at par value. The lower the pricing, the higher the interest rates. The market price in this case = F-D, Where D= (5/100)*(50,000,000)*(180/360) D=1,250,000. Applying the formula F-D, 50,000,000-1,250,000 Financing raised = $48,750,000 Question 5 The required rate of return that an investor needs as a percentage in order to purchase a certain asset. The required rate of return offers the investor with an adjustment of the price; they are willing to pay for a given asset. The ANZ bank (ANZ: AX) bank current stock price is 31.32 (Bloomberg news). Based on the information, the maximum price to pay for the stock ought to be: (0.91/ (0.09-0.06)) The maximum price the investor should pay for the stock is $30.33 Based on this model, I would not buy the share. Fundamentally, the share price of ANZ Bank is overvalued. If, the investor were to consider the technical analysis affecting the stock, it may sum up as a good buy with Australia being a major contributor in the commodities market and the expected geopolitical factors emanating from the current crisis in the Middle East. References Zhu, X 2012, 'The Global Financial Crisis: How China Responded to It through Legislation', Chinese Economy, 45, 3, pp. 42-55. McKibbin, W, & Stoeckel, A 2010, 'The Global Financial Crisis: Causes and Consequences', Asian Economic Papers, 9, 1, pp. 54-86. Walker, G.A. 2013, "Financial Crisis and Financial Resolution", Banking & Finance Law Review, vol. 29, no. 1, pp. 55-84. Akdogu, S.K. & Umutlu, M. 2014, "The Link between Financial System and Economics: Functions of the Financial System, Financial Crises, and Policy Implications", International Journal of Financial Research, vol. 5, no. 4, pp. 52. Antzoulatos, A, Panopoulou, E, & Tsoumas, C 2011, 'Do Financial Systems Converge?', Review Of International Economics, 19, 1, pp. 122-136 Read More