Financial Institutions and Markets - Assignment Example

Financial Institutions and Markets Name: Lecturer: Course name: Course code: Date: Question One Factors causing the Global Financial Crisis Global financial crisis is considered the most pervasive economic obscurity which as negatively suppresses the economy of the country’s financial markets and the real economy. The global financial crisis has great depressions and difficulties in the country’s economy since it has affected tremendously most of the key economic fields thus overwhelming economical performances and conditions (Graham K. and Wilson Grant, 2012). The global financial crisis majorly deems the financial worthiness of financial Institutions such as banks thus degrading the economical contributions. The major factors that crash down the financial crisis is as a result of combination of complex factors such as easy credit conditions which enhances higher changes of lending risk, skeptics of capitalism Real estate bubble, international trade imbalances and financial policy preference related to both government expenses and revenues. Causes of global financial crisis a) Easy credit conditions U.S. Financial Crisis Inquiry Commission January 2011 reported that the global financial crisis is majorly caused by the extensive failures in financial regulations. Unscrupulous Federal Reserve’s lending failures lead to vivid breakdowns in corporate governance due to irresponsible financial considerations has stanch the surge of toxic borrowings of financial system (Chan-Lau, 2010). American international group financial product reports a collateral debt obligation and issuing large numbers of mortgage at a low price turns hammer the CDO system. Financial institutions such as banks were given the authority to develop their own model in regulating their capital approximation for risk. Thus the model was standardized to a short period of time without accommodating future financial uncertainties, such as default in repayment which might cause insecurity in their operation. The graph depicts an increasing trend of lending from 2000 towards 2006 and a consequent decline in the lending in the following year. This is as result of poor credit measures that consequently lead to default in payment thus subjecting the firms to financial crisis. The deliberate measures to safeguard the financial institutions against mortgage lending incentives should be to enhanced secure the lending financial crisis. b) Real-estate bubbles The housing bubble resulted because of long term low interest rates stipulated US Federal Reserve and the controlling interest rates of European countries such as Spain and Ireland. Large property bubbles in European countries was configured as a result of decrease in net interest income which is attributably caused by the risk of refinancing which arise as a result of increase in cost financing without consequent augment in the institutions earnings rate. (Jonathan A.Et Al, 2011) Argues that, the Federal Reserve slashes the interest rates and the tax advantages imposed on deducting interest on borrowings policies created incentives of borrowing at one percent and acquiring houses going up at three percent. The speculation that prices will increase in the future, low interest rate on mortgages and low down payment encouraged borrowing of mortgage to acquire house and property to be sold at higher expected prices. The housing price started to decline because mortgage interest rate started to short up creating poor refinancing situation thus leading to failure of paying their borrowings hence financial crisis as depicted in the graph below; c) International trade imbalances and Fiscal policies International trade imbalances and fiscal policy choices such as global variances in interest rates, borrowing policies and government regulation in relation to revenues and expenses defines the economical performances and conditions. These variances lead to significant economic speculations such as increase venturing when global group of fixed income securities increased with an expectation of higher returns (Senhadji S Et Al, 2010). However the trade imbalance and monetary policies conceptualize on the global economic challenges that facilitate financial crisis. Question Two Consequences of the Global Financial Crisis a) Unemployment rises Struggling financial institutions and markets engraves the back lending roots a credit crunch that restricted borrowing to most of the consumers and some governments financial institutions. The credit crunch spends borrowing to invest and spend during the pre-crisis levels thus higher employment rate (Jonathan A.Et Al, 2011). Financial crisis cut back their business investments due to flattered demands and decline in their workforces. Redress of company’s liquidity due to the financial Crisis induces a way to the recession that has caused an increase in the rate of unemployment due to the adverse lending attitudes that have made lending obligation to consumers untrustworthy. This results to the financial institution losses that surges and deepening the credit crunch, thereby creating a negative response loop thus resulting to increase in the unemployment rate due to lack of financing opportunities. During the Pre-crisis error, the financial system in particular institutions reveal a tremendous pressure in the real economy resulting in higher income flow and high rate of employment (Fabrizio, 2010). However, the changes ensuing crisis demises that induced substantial losses to several counterparties forced investors to withdrew from the markets and liquidity dried up markets thus leading to high employment rates b) Central government debt rises Global financial crisis induce considerable pressures on financial institutions to inject massive liquidity that contributed to closure of institutions (World Bank Staff, 2011). Many financial institutions invested heavily on the collateral debt obligation when the demand of asset commercial paper deformed amidst increasing mortgage non-payment, and decreasing their worth thus lead to institutions having the reclaimed asset at a lower price as compared to current market price. These made financial institutions have liquidity crisis and obtaining loans became difficult as fallout from the sub-system lending bubble burst hence effects of credit crunch. Therefore financial institutions that were affected by this had to realize huge loses that made others to close down some of their institutions branches. However due to significant crisis in collateralized markets, capital markets collaterals increased and low quality collateral became more difficult to borrow. However these made government financial institutions even hand the continued securitizations to limits crash that redresses the government debt capacity. Question Three Effects of Global Financial Crisis on banking sector in the US and Australia Most of the US and Australian banks such as Reserve Bank of Australia and US federal bank diversely invested heavily on the collateral debt contract. During the demand of asset bank commercial paper during the summer period of 2007 deformed amidst increasing non-payment mortgage and declining worth of the house edge funds which lead the banks having the reclaimed asset at a reduced price as compared to current market price (Chan-Lau, 2010). These results to high financial liquidity crisis in the banks have lead to difficulties in obtaining the loans became difficult as fallout from the sub-system lending bubble burst hence affecting the credit crunch. Therefore, the unscrupulous lending of banks left the financial institutions with immense loses that lead to liquidation of other banks and their branches. Financial crisis redress US and Australia’s banking sector capital stocks where stock market around the world crashed since of no buyers in the market (Wachter, 2006). This became highly volatile and made consumers self-confidence to thump along as everyone was keen on what was to happen in the future after the credit crunch, therefore many banks made massive losses as they had this capital stocks as closing in the balance sheet. The effect of overstating the accounts lead to massive losses hence makes liquidate the banks. Another major factor that crash down the to banks is the aspect of combining the major complex factors such as easy credit conditions which enhances higher changes of lending risk. Question Four a) Finances raised by Commonwealth Bank on issuing 500, 5year bond at 6% annual coupon and $1000 face value Finance raised on issue of bond = (Total amount of bond – Interest payable) = 500 x 1000 – (500 x 1000) x6% =$500,000 – (500,000 x 6%) = $500,000 – 30,000 = $470,000 b) Effect of price of bond on increase of the Commonwealth Bank’s credit rating from AA to AAA Credit rating refers to the firm’s credit worthiness conducted by rating agencies based on preceding dealings in settling the financial obligation without default. The firms credit rating has inverse relationship whit its credit worthiness where the higher the credit rating (AAA) indicate the borrower’s credit worthiness and lower (AA) credit rating signifies that borrower can default payments (Allen F. and E. Carletti, 2008). However based on the credit rating increase in firms credit rating will reduce the coupon rate thus decrease in the price of the bond. Question Five a) Finances raised by Apple on issuing bank bill of $50,000,000 face value, 5% interest and maturity of 180 days Finance raised on issue of bank bill = (Total amount of bill – Interest payable) = $50,000,000 – ($50,000,000 x 5%) = $50,000,000- 2,500,000 = $47,500,000 b) Credibility of Apple in issuing Commercial paper rather that a bank bill Commercial paper and Bank bill are both considered short term marketable securities. However, well established bank with high credit ratings should consider issuing a commercial paper since it is cheaper to draw rather than a bank bill. Commercial paper also has extensive range of maturity hence flexible and it does not lien on the firm’s assets. Apple should also issue commercial paper rather than bill since commercial paper provides investors with valid opinions of the company’s ability in paying its debt. Question Six Consideration of buying the share today Required return = 9% Dividends (d1) = $0.91 Growth =6% Ke = = 30% However from the calculation above ke is more than required return thus the share should be bought today. Buying the share today will call for 6% growth of dividends for perpetuity. Reference List Allen F. and E. Carletti, 2008. “Should Financial Institutions Mark to Market?”. Bank of France Financial Stability Review , 12, pp.-6. Chan-Lau, J.A., 2010. The Global Financial Crisis and its Impact on the Chilean Banking System. I.M.F press. Fabrizio, S., 2010. Coping with the Global Financial Crisis: Challenges Facing Banking Sector. In IMF Publication. Cengage Learning. pp.3-10. Graham K. and Wilson Grant, 2012. The Consequences of the Global Financial Crisis. In The Rhetoric of Reform and regulation. United Kingdom: Oxford university Press. p.8. Jonathan A.Et Al, 2011. The Impact of the Global Financial Crisis on Emerging Financial l Markets. Newyork: Emerald Group Puplishing Limited. p.265. Senhadji S Et Al, M.Y.K.A., 2010. Impact of the Global Financial Crisis on the Gulf Cooperation Council Countries. United States of America: International Monetary Fund Publishers. Wachter, H.R.a.S., 2006. “Bubbles in Real Estate Markets,” AssetPrice Bubbles: The Implications for Monetary, Regulatory, and International Policies. Cambridge MIT Press. World Bank Staff, 2011. World Bank Group's Response to the Global Economic Crisis. World Bank Publication. p.72. Read More