Financial Market Instruments - Assignment Example

A Report on Financial Market Instruments Table of Contents Introduction 3 UK Equities 3 Five Year Outlook for the UK Equities 4 Factors that will drive Future Performance of UK Equities 4 Fixed Interest Market 4 Five Year Outlook for the Corporate Bonds and UK Government Debts 6 Factors that will drive their Future Performance 6 UK Property 7 Five Year Outlook for the UK Property 7 Factors that will drive Future Performance of UK Property 8 Commodity Markets 8 Five Year Outlook for Oil and Gold Market 9 Factors that will drive their Future Performance 9 Recommendation on the Best Asset Class 10 Conclusion 10 Reference List 12 Introduction A financial market brings sellers and buyers together for the purpose of trade in the financial assets like commodities, stocks, currencies, derivatives and bonds. Financial market’s chief purpose is to transfer risk and liquidity, raise capital and to set/locate prices especially for the universal trade. Among the different components of financial market, most frequently employed are capital and money markets. Money markets are generally employed for the basis of short term i.e. for short-term assets. On contrary, capital markets are utilised for the assets of long term such as equities and bond. Together the capital and money markets are used to manage risk and liquidity for individuals, governments and companies. The main players in the financial market are banks, households, sovereign entities, firms, insurance companies and other financial institutions (Williams, 2011). The report will focus on the UK capital market including equities, corporate bonds and government debts, UK property and commodity markets of UK. The commodity market will include gold as well as oil markets of United Kingdom. Five year viewpoint of the following markets will also be provided in order to provide recommendation on the best asset class. Factors which will drive the upcoming performance of UK capital markets will also be taken into consideration. UK Equities The equity market of UK is the global market as more than 70% of profits generally come from the overseas; therefore it reflects the international market. It has fairly a big sector of resources and the mining and oil sector are the major sectors. They together contribute more than 15% and due to this reason the economy of UK is quite strong (Wall, 2015c). Though, the equity market of UK is expected to become volatile because of the turbulent election prevailing in the country. The overall increase of the revenue is also anticipated to remain exigent in the current year i.e. 2015. The alteration in the agenda of general election is the major reason of ambiguity for the equity market of the United Kingdom (Barnett, 2015). The main factor which is constantly overshadowing the equity market performance is the interaction between growing cynicism of the investors on the worldwide economic viewpoint and the capability of the policymakers towards creating the circumstances to strengthen prospects of growth where necessary. The recent euro zone performance and the Chinese economy’s presentation is concerning. This is due to the reason that weaker than anticipated progress in these regions as well as deflationary forces will have an impact on the economy of the country, which has performed comparatively well in the year 2014 (Barnett, 2015). Due to these reasons, the growth of the revenue is also expected to remain demanding or challenging. Five Year Outlook for the UK Equities The latest election has endangered the equities market in the United Kingdom, but at present the country has some political stability. The equities have united or rallied to some extent as well as the pound has also bounced (Wall, 2015a). The mining and oil sectors are contributing more than 15% to the equity market and therefore strengthening the UK’s economy (Wall, 2015c). Moreover, an attractive flow of dividend from the equity market indicates good growth potential of the equity market. So, five years from now it is expected that the equity market will grow. Factors that will drive Future Performance of UK Equities The economy of UK is actually in better shape. This is because the employment is continuously rising and growth in the wages has also been observed (Wall, 2015b). If this will continue in the near future i.e. for the next five years, then the economy of the country will keep rising and the individuals will not hesitate to invest in the equity market. The flow of dividend from the equity market of UK is quite attractive which contribute towards the strong economy of the country (Wall, 2015c). Overall, the employment rate, rising wages and the dividend flow will drive the upcoming performance of the equities market. Fixed Interest Market Capital markets of UK play a significant role in funding or financing the companies. From 2009, the issuance of corporate bonds in the United Kingdom has been strong, but then also the collective business investment in the country has remained feeble. The main intention of the companies which issue bonds is to cut the debt like bank loans. It has been analysed that that is extensive heterogeneity in the investment behaviour of companies in UK. Companies that make use of the capital markets have augmented their investment considerably since 2009. However, their growth of investment fell in the year 2012, which focuses on the fact that others factors in addition to the access to finance is also having an impact on the investment decision of the firms (Farrant et al, 2013). Figure 1: Percentage of issuance of corporate bonds by the companies of UK, US, France and Germany (Source: Farrant et al, 2013) The issuance of corporate bonds by the companies has raise from 10% in 1992 to almost 25% in the year 2012 (See Figure 1). The percentage of the UK companies in terms of bond issuance is higher than France and Germany but lower that United States (See Figure 1). Records from Dealogic propose that the companies in the United Kingdom issued approx £220 billon of the corporate bonds in gross terms between the periods 2009-2013 (Farrant et al, 2013). Figure 2: (Source: Farrant et al, 2013) Figure 2 shows the issuance of collective gross corporate bonds starting from 2003. Issuance in the year 2009 is more than that of 2003-2008. The companies in the year 2012 issued bonds at faster rate and it has been continued in the year 2013 (Farrant et al, 2013). Figure 3: 10 year nominal spot rates of UK (Source: Guimaraes, 2012) One measure of the market rate of interest is the “yield on government bonds” (Guimaraes, 2012). The 10 year yield on nominal spot is a yardstick for the borrowing costs of government have currently been at low end (See Figure 3). Since the financial crisis, there has been fall in the government bonds which indicates the lower expectations or prospects of the real rates of interest. It also signifies that the policy rates will also remain low. Both the real and inflation rate prospects resulted in the fall of nominal rates. Likely real rates have also accounted for the decrease in the nominal yields (Guimaraes, 2012). Five Year Outlook for the Corporate Bonds and UK Government Debts The corporate bonds of UK offer good returns for the year 2015 (Stewart, 2014). A rising trend has also been also noticed in the issuance of the corporate bonds by the firms since 2012. By observing the proposition of good returns by the corporate bonds, it is expected that this trend will continue in the near future. Therefore, from five years from now it is anticipated that corporate bonds will provide good returns. The yields on the government debts were also extremely low so it cannot be said whether it will perk up in the future. Though, the change in the monetary policy may improve the situation. Factors that will drive their Future Performance The astonishing experiments in the monetary policy of UK have led to low volatility levels and low markets saturation with liquidity. The features that will result in the good future performance of the corporate bonds as well as government bonds are the noteworthy changes in the monetary policy. As of now, the corporate bonds of UK offer a viable investment opportunity because of their structural supports, relative value and also because of technical drivers (Stewart, 2014). UK Property The property market of UK is on the two-speed route i.e. London is deteriorating while the rest of United Kingdom is rising. It has been explored that 7.24% of the property prices increases in 2014 but was lesser than 8.4% gain which was recorded in the year 2013 (Global property Guide, 2013). The slowdown in the activity of housing market is quite surprising seeing the stable gains in the employment, growth in the wages, and decline in the mortgage rates. In the starting of 2015, the house prices in London have declined but slowly it has been recovering and recently London is also experiencing a rise in its property prices (Global property Guide, 2013). The prices of the property i.e. the house prices especially the main property market are rising. The price of the properties in London is influenced by the general election which has taken place recently. There is a possibility that London will experience a surge in the sales of property as the citizens who are not thinking of buying, mainly the overseas consumers, now are going ahead as well as deciding to buy the property. House prices are likely to rise by 10% within months (Propertywire, 2015). The rising prices are creating trouble for many buyers. Increasing the home supply is considered as the only means for the property buyers to overcome the difficulties. Lately, London is regarded as the safest place to make investment in the property. Those who are deeming about selling the house but awaiting the political firmness should make their move now (Propertywire, 2015). Five Year Outlook for the UK Property By observing the recent trends of the increase in house prices, it has been discovered that the prices of the property will increase in the coming future. If this will happen than it will become too expensive or unaffordable for the people to survive in United Kingdom. It has been predicted that the cost of property will hoist approx by 22.8pc in the next 5 years, while the property price in Greater London is expected to increase by 29.4pc (See Figure 4) (Telegraph, 2015). Figure 4: Growth of house price by 2020 (Source: Telegraph, 2015) Factors that will drive Future Performance of UK Property There are various factors that will drive the upcoming performance of the property market. The population and immigration growth in the United Kingdom, especially in London is very strong which will result in the growth of property market. Moreover the interest rates are on decrease with a growth of money supply by means of quantitative easing. Therefore the economies of United Kingdom, particularly the London will boost in future. Commodity Markets The commodity market will be explained by means of oil and gold markets of United Kingdom. The oil prices has fallen drastically thus impacting the stock markets and inflation of UK. It has fallen from $110 in 2014 to $56 per barrel in 2015 (Wall, 2015d). The excessive volatility will provide benefit to the people and harm to the investors, who have invested in the oil companies. Both the supply as well as demand factors plays considerable role in the decline of oil prices (Wall, 2015d). Fluctuations in the gold and oil market will affect the economy of United Kingdom. The gold price has risen in 2012 but then it has resulted in the great downfall. It has been discovered that after 2012, there were incessant decline in the price of gold in the UK market. The prices of gold market dropped due to shortage of demand and market manipulation. Quantitative easing also influences the price of gold (Market oracle, 2012). Figure 5: UK gold prices from 1968 to 2015 (Source: Ibma, 2014) Five Year Outlook for Oil and Gold Market Recently, the prices of oil have plunged heavily, thereby affecting producers, consumers, governments and exporters. It has been analysed that the gold and oil market of United Kingdom will remain same in the upcoming five years. This is because the prices of gold remains low after 2012 and therefore it is expected that it will continue in future also. In case of oil price, it has been explored that after 2014 it remained low and thus it is assumed that it will continue to remain in the same level with a slight change in it. Factors that will drive their Future Performance The oil market of United Kingdom can only improve by increase in their demand. It can also recover by the improvement in the country’s economy such as rise in the GDP (Forbes, 2015). The future performance of Gold market can also be improved by the increase in their demand. An augmentation in their demand will lead to the increase of gold prices and therefore boost the gold market. Recommendation on the Best Asset Class It has been discovered that both the equity and fixed interest markets of United Kingdom will perform strongly in the coming five years. An attractive flow of dividend from the equity market indicates good growth potential of the equity market but the recent election has threatened the equities market. On contrary, in terms of fixed interest markets, the corporate bonds offer good returns for the year 2015. By observing this it has been expected that corporate bonds will provide good returns and will perform better then the equity market because of the unexpected volatility of the equity market. Looking at the investment decision, investing in corporate bonds is considered as more beneficial than equity market. Making investment in equities is regarded as extremely risky because of the instability of the equity market. The corporate bond which offer high yield are not considered risky as in case of equities because of their deleveraging feature and they also provide high return. Nothing is guaranteed in the equity market whereas a bondholder gets a fixed interest on their money. Investing in corporate bonds will provide good return and also the expected return is fixed irrespective of the change in the interest rates. This saves the bondholder from the rising interest rates (Kiesel, Scherer and Zagst, 2010). Therefore it is recommended that corporate bond is the best asset class and also the viable option for making investment because it provides attractive yields and safety. This is because it is allotted a rating on the basis of its obligation repayment ability and credit history. Higher rating signifies the safe investment. By observing this, one can know whether it is safe to invest in corporate bonds (Kiesel, Scherer and Zagst, 2010). Conclusion The report has been prepared to show the outlook of the UK capital market. The equity market of UK is expected to become volatile because of the turbulent election prevailing in the country. The recent election has threatened the equities market in the United Kingdom, but now the country has some political stability. However, an attractive flow of dividend from the equity market indicates good growth potential of the equity market. The corporate bonds of UK offer good returns for the year 2015. Most recently, the property market has been threatened or challenged by shortage of stock. Though, it is expected to change to a certain extent thereby generating more struggles for vendors. The commodity market has also been endangered due to the fall in their prices. By observing the facts and features of different asset classes in UK, it has been recommended that corporate bond is the best asset class and also the viable option for making investment. 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[pdf] Available at: < http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb120302.pdf> [Accessed 29 May 2015]. Ibma, 2014. London is home to the international prices for gold, silver, platinum and palladium. [online] Available at: < http://www.lbma.org.uk/pricing-and-statistics> [Accessed 29 May 2015]. Kiesel, R., Scherer, M. and Zagst, R., 2010. Alternative Investment and Strategies. London: World Scientific Publishing Co. Pvt. Ltd. Market oracle, 2013. Gold price drop due to market manipulation or lack of demand. [online] Available at: http://www.marketoracle.co.uk/Article43562.html.> [Accessed 29 May 2015]. Propertywire, 2015. UK property market set for further growth due to stable election result. [online] Available at: http://www.propertywire.com/news/europe/uk-property-market-election-2015050810486.html.> [Accessed 29 May 2015]. Stewart, A., 2015. Outlook 2015: UK Corporate bonds. [online] Available at: < http://www.schroders.com/tp/economicviews/economic-and-strategy-viewpoint?id=a0j5000000A1Gn3AAF> [Accessed 29 May 2015]. Telegraph, 2015. If house prices forecasts are on the money it will become “unaffordable to exist” in Britain. [online] Available at: < http://www.telegraph.co.uk/finance/property/11625575/If-house-price-forecasts-are-on-the-money-it-will-become-unaffordable-to-exist-in-Britain.html> [Accessed 29 May 2015]. Wall, E., 2015a. Outlook for UK Equities. [online] Available at: < http://www.morningstar.co.uk/uk/news/137831/outlook-for-uk-equities.aspx> [Accessed 29 May 2015]. Wall, E., 2015b. UK stocks will rally for 5 more years. [online] Available at: < http://www.morningstar.co.uk/uk/news/136486/buxton-uk-stocks-will-rally-for-5-more-years.aspx> [Accessed 29 May 2015]. Wall, E., 2015c. How to find yield in UK equities. 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