Financial Instruments Evaluation - Assignment Example

Instruction: Task: Financial Instruments. Introduction. In the real world, companies and individuals may want to invest in assets with high liquidity rates so that they may be able to meet certain deadlines. On the other hand, they may borrow to meet such deadlines, but the most common practice is to invest in things that have high liquidity as this is more feasible than borrowing. Consequently, the following report is aimed at explaining two significant elements of the financial market; the money market and the capital market. These are essential in helping to solve the issues highlighted above. In addition, this report looks at the various risks associated with both the money market and capital market in addition to a comparison with the existing market data. Final recommendations are also provided in light of the risks and benefits identified. Money Market Securities. These refer to the elements of financial markets that mature within a short time, usually within one year or less. Otherwise known as debt securities, they are mainly issued to individuals interested in obtaining short-term financing. In essence, the money market is specifically the financial market for short term liquidity within the international financial system. It is made up of various parties that are classified as borrowers and lenders as per their activity in the market. These parties also include the financial intermediaries, the companies, and the treasury that issues the telecommunication network in the primary market. One of the main features of the money market securities is their liquidity, and the fact that they can easily be sold in a secondary market. The following are the major features of the money market instruments: They are much safer due to their short term nature as this eliminates any uncertainties brought about by long-term commitments. Very high liquidity, which is the main feature of these instruments. Investors can therefore access their money much more easily. There is quite a variety of them such as T-bills, municipal bonds, certificate of deposits and commercial paper. Discount pricing such that the instruments are generally issued at a certain discount. The following are some popular money market securities: Treasury Bills – this is a way that the US government uses to generate money from the public. They are sold at a certain discount below their face value and can be issued with different maturity rates such as one, three, or six months. T-bills have certain advantages such that they are generally affordable due to their discounts. They are also the safest securities due to their backing by the US government. In addition they are exempted from both state and local taxes. However, they are mainly restricted by their limited growth as a result of being viewed as risk-free. Therefore, they cannot earn optimally. T-bills work in such a manner that an investor can submit competitive or non-competitive bids for which they receive full amounts of the determined securities. For competitive bidding, one submits the return they would like to receive. Consequently, a higher return might mean no limited securities. Commercial paper – this refers to a short-term loan that a corporation issues in order that it may finance inventories. It is unsecured, meaning that there is no need for securities. Moreover, commercial paper is usually issued at certain discounts and always reflect the interest rates currently in the market. It can be issued in US dollars by only the largest corporations due to the unsecured nature. It also matures in between 1 and 270 days, and its interest rate reflects the corporation’s level of risk. Advantages It is unsecured hence doesn’t attract any legal claim. It is swift and cost effective. Cheaper compared to other means such as bank loans. Disadvantages It is only available to a select few profitable corporations. In certain instances it is regulated very closely. Certificate of Deposit (CD) – this is a deposit held for a fixed term with a bank. Maturity can be up to a year. Federal funds – these are borrowings aimed at maintaining the reserve that banks maintain with the Federal Reserve in the US. Repurchase Agreements – refers to short-term agreements between seller and buyer that the seller may later on repurchase the securities. Capital Markets Capital markets are markets for the trading of various equity and debt instruments to facilitate the proper functioning of an economy. This trading between institutions and individuals can be done in public or private through the capital market to raise funds. It is long term, maturing in at least 10 years. Given that most governments and corporations require funds to facilitate the various long-term obligations that they may have, they often resort to the sale of securities to raise the funds required. This is mainly through the sale of stocks and bonds that are under the company’s legal entity. All this is done within the capital markets. An explanation of the stock and bond markets can sufficiently highlight this. Stock Market. The stock market is the platform that facilitates the trading of shares for publicly traded corporations. Shares are very important as they yield capital for the company. Stock market is divided into two: primary and secondary market. The primary market is mainly for the issuance of new shares while secondary market handles succeeding trading on the issued shares. Bond Market. This is essentially for securities issued by the government. It facilitates the trade-off of debt securities. It works such that an investor avails funds to an issuing entity, which is defined by a certain period and fixed rate. Consequently, the government or any other institution can easily generated funds through the issuance of such bonds. There are different types of bonds: Corporate bond – this mainly refers to the securities issued by corporations to investors, hence the name. US treasury bond- this is issued by the US treasury and aimed at financing the various deficiencies that the US government may face. Agency bonds – these are bonds issued by agencies. An agency is a body affiliated with the US government, but different from it. Municipal Bond – this is issued by an agency, or in extension a certain faction of the government such as municipal or local government. In addition to the US treasury and corporate bonds, these also yield semi-annual interest overheads. Conclusion In the current society, the need to require immediate funds for a short-term obligation or generate revenue for long-term goals often necessitates different adjustment mechanisms. This is where market and capital securities fall in, and the various implementation techniques as highlighted above. Each has its own terms and implementation means due to their different natures. In all, they are the most defining elements of world economy at large. Read More