International Financial Markets - Essay Example

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International Financial Markets Question 1: (a) Issues that have affected the international bond markets since the start of the global financial crisis. Sovereign debt, otherwise known as public debt, is borrowing incurred by governments. This figure has risen significantly and become unsustainable for at least three Eurozone countries, namely Greece, Ireland, and Portugal, which have all turned to the International Monetary Fund (IMF) and other Eurozone member states for financial assistance…
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Download file to see previous pages Reasons for this trend are the fiscal stimulus packages, nationalization of private-sector debt, and reduction in tax revenues (Nelson, 2012). While government securities are considered close to risk-free, there have however been worries in 2010 that U.S. municipal bonds may default because of lack of liquidity, a fear which proved unfounded (MeritWealth, 2011). When the government requires high levels of borrowing, it tends to raise the yield on its bonds in order to attract investors. In a low interest environment, high-yield bonds become attractive to investors because the present value of high-yielding bonds makes the bonds more valuable when traded in the open market. However, by increasing the yield on its bonds the government crowds out private business and credit tends to become more costly – that is, added risk premiums increase interest rates over that offered by the government, discouraging private borrowers from resorting to bond financing because of the higher default risk involved. The result is a credit crunch that reduces funding to business and slows down productive activity, eventually causing downsizing, lay-offs and company closures. The central bank resorts to quantitative easing to introduce liquidity in the economy to spur nominal spending; this is done by purchasing financial assets from the private sector. The new central bank money used to pay for the assets increases the money held by banks and increases the level of deposits held by private parties. Quantitative easing is seen to help restore the inflation rate to positive levels when the economy is too weak that deflation (negative inflation) threatens to set in (Benford, et al, 2009). As for other developments, retail bond trading (lower-denominated bonds offered to individual investors) is seen as the better alternative to institutional bond trading. Retail had been growing when institutional was shrinking in the past crisis, due to its lower risk (Kite, 2008). Furthermore, emerging market dollar bond issuance has surged to $100 billion in 2012, as investment funds found safer markets in emerging economies little affected by the subprime financial crisis (Natarajan, 2012). Another alternative is sukuk bonds, which are Islamic financial instruments resembling conventional bonds but, consistent with Shariah law, are not debt instruments and do not pay interest. Instead, sukuk are ownership investments representing “legal/beneficial interest in specified tangible assets and/or services and/or projects.” Sukuk investments yield pre-determined returns, and specifies profit-and-loss sharing between fund user and provider (Adam & Thomas, 2004, p. 54-55). Contingent convertible bonds, also known as CoCo bonds, are a novel way by which banks may raise capital. These are bonds that automatically convert to equity when a particular trigger takes place, such as when the issuer needs money (Pietersz, 2012; . The CoCo mechanism quickly converts temporary capital (debt capital, which must be paid back) to permanent capital (equity, which however tends to dilute shareholdings). As for the future of securitisation, there is still a great need for developing securities which businesses resort to for hedging and risk management. However, new regulations have been adopted to ensure that the ...Download file to see next pagesRead More
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