Investment Management in Increasing Federal Fund Rate - Essay Example

Practice of Investment Management Table of Contents Introduction 3 Equities Country Indices 3 Sovereign Bonds 5 Commodities 7 Foreign Exchange 9 Desired Portfolio 12 Conclusion 13 References 14 Introduction The objective of the study is to determine the impact of current trend of increasing federal fund rate on equity, sovereign bonds, commodities, and foreign exchange. Subsequently, the study will also be executed with the intention to forecast its return in the short term and long term in the current scenario. Eventually, a desirable recommendation to the establishment of effective portfolio management is expected. Equities Country Indices Interest rates have major impact on a nation’s equity indices. This impact on equity indices is also prominent in the US. In this regard, it is notable that the slightest change in the interest rates leads to massive change in the equity market. This change in the interest rate is also notable in the federal rate. The hike in the federal rate does not have a major immediate effect in the stock market of the US. This suggests that in short term, the impact of federal rates on the equity indices is not as prominent as deemed. However, it has a gradual, but significant impact on equity indices of the nation in the long term. In this regard, it is notable that the hike in the federal rate leads to the increase in the equity indices of the nation at large. The data collected from Bloomberg L. P. (2015) reveals that there has been an increasing trend in the federal fund rates in the US within the last one year i.e., from March, 2014. This is eminent from the increasing linear slope through graphical representations of the data. The underneath graphical representation depicts the same in a compressed but elaborative form. The set of valuable data collected from Market Watch, Inc (2015) also suggests that there has been an increasing trend in the NYSE Equity indices from March 2014. Further, a trend analysis of the collected data predicts that there would be an increase in the equity market in the long run i.e. 2 years. The quantitative analysis predicts that equity indices of NYSE would increase to 11521.72 points. However, it is also estimated that the increasing trend would not have a major impact on the short-term operations, which can be 3 months in general. The statistical analysis predicts that after three months i.e. May 2015, the NYSE equity index would have 11012.05 points. Correspondingly, increase in the equity market through the rise in the federal fund rates is also proved with the help of positive correlation between the two variables. The correlation value determined is 0.319133833 (Market Watch Inc, 2015). The underneath graphical representation depicts the short term (3 months) and long-term (2 years) NYSE equity indices. Sovereign Bonds The increases in the federal rates also have major impact on the sovereign bonds or the government bonds of a nation. This is also notable in the sovereign bonds in the US. In this regard, in order to determine the impact of federal rate, hike on the government bonds data regarding the government bond yields percentages from March 2014, has been collected from Trading Economics (2015). These data are statistically analysed, which suggested of a weak positive correlation of 0.043947828 with the federal rates. However, it is also notable from the statistical analysis that despite the weak positive relation with the increasing trend of federal rates, sovereign bond yield percentage has a negative trend. The statistical analysis in this regard forecasts of a fall in the yield percentage of sovereign bonds up to 1.96 in the next three months i.e. May 2015. Moreover, it is also estimated that the yield percentage would further fall to 0.784 in the long term i.e. 2 years. The prime reason of fall in yield percentage of sovereign bonds in US is because of the increase in the federal rates due to the higher investment from the investors. The high investment in government bond is because of the risk free character of sovereign bonds. Thus, high investment leads to low yield in this form of bonds (Trading Economics, 2015). The underneath graphical representation portrays the forecast of US sovereign bond yields in the next 3 months and 2 years respectively for short term and long term operations. Commodities The rise in federal fund rates has a significant impact on the commodity market. This is evident from the statistical analysis by the data collected through Fusion Media Limited (2015) and NASDAQ (2015). These sources provided data for the commodities including coffee and gold. From the statistical analysis, it is eminent that federal fund rates and the price of coffee have an inverse correlation. However, this inverse relation is very weak, which is -0.039840005. Similar correlation is also notable with gold, which have a correlation value of -0.171645194. Moreover, the fall in the price of these commodities in the short-term and long-term period is also forecasted through statistical analysis. This suggests that the price of coffee would fall to 1178.3 USD per pound and 93.044 USD per pound in the next 3 months (short term) and 2 years (long term) respectively. Moreover, the price of gold would fall to 1178.3 USD per 100 oz and 998.12 USD per oz in the next 3 months (short term) and 2 years (long term) respectively. The reason behind the decreasing trend in the commodity market also depicts the decrease in the money flow in the nation due to high federal fund rates. This eventually leads to the fall in the overall inflation rate in the nation, which also implies in the fall within the commodity market (Fusion Media Limited, 2015; NASDAQ, 2015). The underneath graphical representation forecasts 3 months (short term) and 2 years (long term) price of coffee and gold. Foreign Exchange The data collected through the source XE (2015) suggested of a direct relation between federal fund rates and foreign exchange rates. In this regard, the two foreign currencies selected are Euro and Chinese Yuan. The correlation value determined between federal fund rates and Euro per Dollar is 0.114895785. On the other hand, the correlation value determined between federal fund rates and Chinese Yuan per Dollar is 0.0948224. This implies in the increase in the value of foreign currency value due to the increase federal fund rates. In other terms, it also implies of the decrease in the domestic currency due to the federal fund rates. This is because of the decreased flow of foreign currencies within the nation due to increased federal fund rates. Moreover, increase in the foreign exchange rate is also evident from the statistical calculation of trend line analysis, which determines its forecast for short term and long term. Correspondingly, it has been estimated that Euro per US Dollar would be 0.904 in next 3 months and 1.219 in the next 2 years. However, the trend analysis also revealed that there would not be such major change in the value of Chinese Yuan per Dollar in the short term and long term respectively. It is estimated that the value of Chinese Yuan per US Dollar would remain at around 6.02 (XE, 2015). The underneath graphical representations depict the forecast of Euro per Dollar and Chinese Yuan per Dollar in the next 3 months and 2 years. Desired Portfolio From the above analysis, it is notable that the decreasing trend in the commodity market in the US would further reduce to a very discouraging value for the investors. Moreover, it is also prominent that the federal fund rate and commodity prices have a significant inverse relation. Thus, there is no point in investing in commodities or commodity market (Fusion Media Limited, 2015; NASDAQ, 2015). Moreover, it is also estimated that federal fund rate have a positive relation with the foreign exchange rates. It also suggests that the current increasing trend in Euro per US Dollar would lead to its increase in the short term and long term. On the other hand, it is also estimated that there would not be any major change in the value of Chinese Yuan per US Dollar in the short term and long-term period. In this context, it is also worth mentioning that the increasing trend of these variables suggests of the fall in the value of US Dollar. Thus, on investing on such sectors of investment, the return would be extremely high. This is more on the foreign currency Euro (XE, 2015). From the statistical trend analysis and forecast, it is estimated that the NYSE equity indices would rise in the short term and long-term period. Although, in the short term there would not be a major return, but in the long-term a significant return is expected. Furthermore, the positive correlation between the two variables also encourages the investors in a significant manner. It is also important to note that this form of investment have high liquidity, which also encourages the investors significantly (Market Watch Inc, 2015). Moreover, it is also observed that sovereign bonds have a decreasing trend. In this regard, it is also notable that sovereign bonds have a positive relation with the federal fund rates. Thus, it is recommended that investors must contribute a minor proportion of their sovereign bonds in their portfolio for assuring risk free returns (Trading Economics, 2015). Conclusion From the study, it can be concluded that investors should invest major proportion in the equity and foreign exchange, which is specifically for Euro. For short-term investment, foreign exchange Euro is the best option. However, for long-term investment, along with the investment in Euro, the investors should also concentrate on equity. Considering higher return in Euro than equity, the investors should invest accordingly. It is also notable that these investment factors involve higher liquidity. Moreover, the investors should also invest in the government operations in minor proportion for attaining a risk free return. References Bloomberg L. P., 2015. US Federal Funds Rate. Chart. [Online] Available at: http://www.bloomberg.com/quote/FDFD:IND/chart [Accessed 12 March, 2015]. Fusion Media Limited, 2015. US Coffee C Futures - May 15 (KCK5). Commodities. [Online] Available at: http://in.investing.com/commodities/us-coffee-c [Accessed 12 March, 2015]. Market Watch Inc, 2015. NYSE Composite Index. Charts. [Online] Available at: http://www.marketwatch.com/investing/index/nya/charts?chartType=interactive&countryCode=US [Accessed 12 March, 2015]. NASDAQ, 2015. Latest Price & Chart for CBOT Gold 100 oz. Gold. [Online] Available at: http://www.nasdaq.com/markets/gold.aspx?timeframe=1y [Accessed 12 March, 2015]. Trading Economics, 2015. United States Government Bond 10Y. Data. [Online] Available at: http://www.tradingeconomics.com/united-states/government-bond-yield [Accessed 12 March, 2015]. XE, 2015. XE Currency Charts (CNY/USD). Currency Data. [Online] Available at: http://www.xe.com/currencycharts/?from=CNY&to=USD&view=1Y [Accessed 12 March, 2015]. XE, 2015. XE Currency Charts (USD/EUR). Currency Data. [Online] Available at: http://www.xe.com/currencycharts/?from=USD&to=EUR&view=1Y# [Accessed 12 March, 2015]. Read More