Financial Intermediaries and The Euro Markets - Essay Example

?Running head: LIQUIDITY AND EUROMARKETS Financial Intermediaries and The Euro Markets Due: QN 1) Introduction The regulation of the financial global market is a problem as there are risks involved in the foreign currency. Some writers argue that most of the firms in the different parts of the world might be experiencing difficulties due to the trading activities rather than banking. The financial environment therefore directly or indirectly influence the financial system of any country. Thus the need for financial intermediaries to act as the middlemen in this transactions is important. Therefore for investors to get profit and the lenders to be able to give away money to borrowers the need for financial markets are vital (Howells & Bain 2007). Financial Intermediation and Liquidity Financial intermediaries can be defined as an institution that acts as the middlemen between the investors and the firms. These financial institutions include chartered banks, insurance companies, investment dealers, mutual funds, and pension funds. Liquidity has been the basis of these kind of transactions between the parties either the borrowers or the investors. It can be defined as the ease with which a given asset can be changed into cash or by getting access to credit. Thus the main concept of liquidity is to obtain cash. Liquidity is often determined by two factors that measure how easy it is to change it into cash or make it possible for borrowers to obtain the cash. The policy interest rates and the structure of the interest rates paid by the borrowers are often the indicators of liquidity. These rates often influence one either to be motivated to borrow or leave the money with the banks. Most of the world banks are involved in market liquidity which is the rate at which a borrower is able to quickly buy or sell the financial assets at a given time without changing the market price (Francis 2008). In the new world there are financial institutions that stand in between parties in any kind of transaction that involve cash. Thus Financial Intermediaries are firms that buy or borrow from consumers or savers and later lend these services or would be cash to other companies or persons that might need resources for investment. Therefore there are different kinds of investments. The insurance policies, buying of stocks, bonds, government treasuries, and mutual funds. All these investments either involve the public investor or the government and the company. Investments that involve a company or the government selling to the public are easily convertible to cash since the purpose of the public is to get cash for their daily living. Moreover, the investments by the government are more liquid than those in the company (Levine 1993). Mutual funds can easily be changed to cash than all the others while the others. Insurance policies since they are the contract or an agreement between the insurer and the insured are difficult to change into cash since one can only pay the amount after a certain incident happens that is often unkown when it will occur. The the government treasuries and mutual funds are just agreements that do not involve cash and thus take time to be converted to cash and the remaining are easily converted in this order: Stocks, and bonds. Therefore in the order of their liquidity they would be: mutual funds as the most liquid asset, then the government treasuries, bonds, stock, and then the insurance pilies as the least liquid asset. Conclusion Financial intermediaries therefore play a vital role in the national economy of any country. In most economies people with more money save them in banks that makes it possible for those with little money to borrow so that they would be able to use them either to run a business or other functions depending on their need. Thus a financial institution such as banks facilitate the flow of funds from savers to borrowers. The financial institutions profit from the spread between the amount they pay for funds and the rate they charge for funds unlike in some traditional transactions where one party would buy a commodity and later re-sell the commodity to a third party at a profit (Pike & Neale 2006). Qn 6) Introduction The eurocurrency and the domestic currency do differ in terms of the number of transactions and the cost of the information that is usually dealt with. While these are done in greater amounts when it comes to euromarkets, the transaction and information costs are smaller in the national financial markets. This is due to the large number of transactions that are involved in the Euromarkets unlike in the domestic markets. In addion, there are a large number of investors in the Euromarkets since iit covers a large geographical area. Since these investors are involved with different currencies the need for Euromarkets is vital for a unified currency exchange. EuroMarkets and Their Growth Euromarkets can be defined as the kind of markets where several countries are involved and thus there is a central currency that facilitates exchange of goods and services. In Euromarkets a country does not necessarily trade with her currency. The prefix ‘Euro’ refers to the fact that these currencies were originally used in Europe. The rise of the dollar as the medium of exchange in the world enabled companies world-wide to hold dollar cash reserves, and banks to encourage their consumers to deposit dollars. However countries that decided to use the dollar never required to regulate the currency of their countries as the dollar did not have any effect on internal money supply (Schenk 1998)             He continues to assert that London played a key role in the development of Euromarkets. Most of the foreign banks were being controlled by UK branches worldwide. However, the main reason behind the development of Euromarkets was the avoidance of national regulations that were put in place by the various world countries to facilitate their trade. The Euromarkets hence provided borrowers and lenders with an alternative to the regulations in their countries. In recent times, the term Euromarkets is less used as the lending currency though not similar with the borrower has now become in most countries (George 1993). Several theories have been put forward to explain the growth and development of the Euromarkets. However, this was before when the rise and growth of Euromarkets had not been properly known. Several factors contributed to the growth and development of the Euromarkets. They include: The return to convertibility, the US balance of payments, US monetary policy and capital controls, the breakdown of the Bretton Woods and the floating exchange rates, recycling and the international debt crisis, and the Inter-bank Market and Financial Innovations (Friedman 1969). The Return to Convertibility and Other Associated Events The sterling crisis experienced between the US and the UK played a key role in the rise of the euromarkets. The Bank of England had to impose more restrictions on the system that it used to give credits to external countries that never used the sterling. Most banks in London and other European countries only allowed dollar deposits from their customers which previously were reinvested in the US. However, as the restrictions again came into being that made it possible to restrict UK banks to use their currency for trading purposes and thus this made it possible for UK to start using dollars in their trading purposes (Howells & Bain 2007). However, the return of convertibility in Europe, and the lifting of the restrictions that were previously imposed in the sterling, provided a way for the rise and development of the Euro market trade. This convertibility scenario permitted an increase in the supply of the dollars that were being held by private firms that made it possible to be used in trade and be exchanged with the local currency (Bakker 1996). The US Balance of Payments A basic deficit in the US balance of payments was experienced because most of the US companies had invested in overseas countries. This had brought much debate if the deficit played any major role in the rise of euromarkets. Friedman (1969) , argued that the deficit never played any role in the rise of the Euro market. He continued to cite by giving an example of West Germany and the existence of a market in Euro-DM despite the German balance of payments surplus. Thus the availability of the Eurodollar depended greatly on the deposits by investors. (George 1993). However, according to Klopstock (1970), the deficit had been an important source of funds for the growth of the market. He implied that the source was from other financial institutions rather than private individuals. For example when individuals went to exchange domestic currency into dollars, to make deposits with Euro-banks, they drew on central bank holdings of dollars, this was because the dollar was not in plenty in the market. According to a Quarterly Bulletin (1964), it agreed with the Klopstock’s works and argued that the deficit was useful in the markets initial growth and development but once the dollar had been well established there were a lot of attraction from the US natives that much created its shortage. Monetary Policy and Capital control of US The problem of dollar deficit made the US government to introduce an Interest Equalization Tax in 1963 to discourage foreign bond issues. The foreign investors and other foreign banks were as a result limited from any borrowing from US banks. This decision by the US affected the euromarket greatly (Howells & Bain 2008). These restrictions made the overseas borrowers turn to the Euro market which in turn helped to keep the dollar interest rates at a relatively high level. Pagano (1993) quotes evidence from Peter & Andreas (1989) on the resulting growth of overseas branches of US banks. He asserts that in 1964, the number of US banks with branches overseas was 11: This rose to 79 in 1970. At the same time overseas investment increased greatly (Valdez & Molyneux 2010). Breakdown of BrettonWoods and The Floating exchange Rates. According to Kerr (1984), Bettonwoods was an economic event experienced in 1971 on the exchange rates. The link between the dollar and gold was broken, and the exchange rate parities were changed according to the Smithsonian Agreement (December 1971). As it became clear, there would be further change in the dollar that was brought about the high demand of the dollar to buy other European currencies that were stronger. Because of this Germany and Switzerland decided to impose capital controls and restrictive monetary policy to reduce inflation. The dollar was devaluated later because of this (Susan 1988). As the fight for the dollar continued most of the world states decided to turn to the floating dollar. Bell (1973) , pointed out that the inflows into Europe in 1970 and 1971, led to increases in European central bank holdings of dollars. He continues to assert that the existence of the Eurodollar market probably would have been the reason behind the re-alignment and the subsequent breakdown to occur sooner than it would have done in the absence of a Eurodollar market. Recycling and the International Debt Crisis After the breakdown of the Bretton woods system, the demand for for oil prices caused the prices of oil in the Euro market to increase. However, the IMFs oil fund facility was inadequate to meet these high demands since the Eurodollar was in deficit, especially from those countries that did not produce oil. The Eurodollar market was attractive because it offered slightly higher deposit rates on funds placed on short-term in their banks, that allowed good returns to those who invested in them as the OPEC members were given time to decide on their long term investments. This led to the rise of the euromarkets as there were much demand from the oil producing countries (Schenk 1998). The Inter-bank Market and Financial Innovations The national markets of any country and the international markets were operating on two mechanisms: The inter-bank mechanism, and the channeling of funds from initial depositors to ultimate borrowers. However, in euromarkets the interbank play a greater role with the introduction of innovations. The importance of the interbanks in the euromarkets allows banks to match the inflow and outflow of funds from deposits and loans by lending excess funds or borrowing to meet lending commitments. Ellis (1981) further clarifies this point by stating that the interbanks play a vital role in fund exchange between different banks. He continues to assert that larger banks however have a smaller percentage of foreign currency than the native currency. In addition, however these banks were never borrowers that make him to conclude that a very large inter-bank segment of the Euro-market performs a necessary and valuable role in linking non-bank depositors and lenders in different parts of the world. Innovations which are associated with non-banks and which have further facilitated to the expansion of the eurocurrency markets arose in the process that included the rollover credits and the syndicated loan system (Peter & Andreas 1989). These innovations reduced the risk of high interest rates when borrowing on short or long term from a bank. This led to the rise of the Euro currency that would help protect the nonbankers against higher interest rates in the name of the inventions. Economic Factors Many economists share a belief that the regulations in most of the states pertaining trade were in the benefit of the US. These regulations further enabled the US pave way for the development of the market for international monetary fund ( Susan 1988). Conclusion Euromarket is the way forward for any country involved in international trade and if it wants to improve her economy. This is because in the Euromarkets there are a lot of investors that have been attracted due to the increased liquidity of assets and the efficient financial services offered across the members of the euromarkets. There is a limited risk to the financial institutions in the euromarkets. QN 7) Introduction Bonds can be defined as an agreement between an investor and a company or government agency to lend money to them so that they would expand their business for a specific period of time with a certain interest rate. Companies and the government agencies in turn sell these bonds to the public at certain rates so that they would make a profit to repay back the investors (Mark 2002). To determine the expected returns of bonds it is important therefore to know that yield is the measure of that return on bonds and their relative value. Bonds The prices of bonds however differ depending on the discount of those bonds. However, their prices are determined by subtracting the bond’s expected value in the market with its present value that it is being sold at by the investor using a given discount rate. Once a bond is measured par coupon implies that the bond’s price will be the same as the face value (Pike & Neale 2006). In this case the bond’s coupon rate equals the required return value of the bond. In the case of the bonds given in this question, bond C is reported correctly unlike the other bonds. Bond C has the same coupon value as well as its return value unlike the other bonds that have different coupon rates with their return values. In the other bonds the coupon rate that makes the present value or the expected value is given. For exemple, to determine the required yield for bond A it would be the coupon rate 6% multiplied by 90 that would give a return of 5.4% while bond Bs return would be gotten by taking the coupon rate 9% multiplied by 96 that would yield 9.64%. The expected value of bond D would be zero since the coupon rate is nil. Moreover, bond E would have a return of 8% multiplied by 10 that yields a return of 8%. Conclusion Understanding the prices of bonds might be difficult but however understanding the basic rules on how the return values of the bonds is determined would be the way forward. It involves identifying the pricing benchmark, determine how it spreads and getting to know about the yield maturity and the spot rates that are able to give the expected return of a bond. References Bakker, A. F., (1996), The Liberalization of Capital Movements in Europe: The Monetary Committee and Financial Integration, 1958-1994. Francis A. L. (2008), International banking and finance, p297-312 Friedman M. (1969), The Eurodollar Market: Some First Principles, Morgan Guaranty Survey, p. 4-14 George H. W. (1993), The Eurodollar Deposit Market: Strategies for Regulation, The American University Journal of International Law and Policy, Vol. 9, p278 Howells, P., & Bain, K. (2007). “Financial Markets and Institutions”. 5th ed Harlow: Pearson Education Ltd.  Howells, P., & Bain, K. (2008). “The Economics of Money Banking and Finance” . 4th ed Harlow: Pearson Education Ltd.  Klopstock F. (1968), The Eurodollar Market: Some Unresolved Issues Kerr, I. M. (1984), A History of the Eurobond Market. The First 21 Years. London: Euro money Publications Levine, R. (1997), “Financial Development and Economic Growth.” Journal of Economic Literature, 35 (2), pp. 688-726. Mark A. L. (2002), Business Finance Online, Bond Price. Accessed 3 March 2012. Link:http://www.zenwealth.com/BusinessFinanceOnline/BV/BondPrice.html Pagano, M. (1993), “Financial Markets and Growth: An Overview.” European Economic Review, 37, pp. 613-22. Pike, R., & Neale, B. (2006). “Corporate finance and investment: decisions & strategies”. 5th ed Harlow: Financial Times Prentice Hall.  Schenk, C. (1998), "The origins of the Eurodollar Market in London, 1955-1963", Explorations in Economic History, 35. Susan, S., (1988), States and Markets, London, Pinter, p105 Valdez, S., & Molyneux, P. (2010). “An Introduction to Global Financial Markets”. 6th ed Basingstoke: Palgrave Macmillan.  Read More