International Financial Markets - Essay Example

INTERNATIONAL FINANCIAL MARKETS By + Introductions Government debtis the debt that the central government owes lenders. Government debts are caused by financial and economic crisis. This could adversely impact on the financial markets. The financial and economic crisis caused a strong increase in public debt in the euro area countries such as Japan, United States and United Kingdom. However, the public debt can be arrested by change of policy in most countries, otherwise, without change of policy public debts will keep expanding in most countries. When the public debt raises the rates of the euro exchange falls and bond yield spreads widened and this resulted to loss of confidence in the financial markets. The main purpose of this paper is to confer the effects of the government debt crisis faced on the small economies on the financial markets (Galati & Tsatsaronis, 2001). http://www.economicshelp.org/blog/5962/economics/main-problems-of-uk-economy/ Public debts are generally caused by decline in positive saving by the government which results to decreased national savings volume. As a result, negative savings leads to interest rates push up which in turn leads to fall in capital growth and investment rates. The slower pace of capital build up deters innovations that may improve the productivity (Wheeler, 2004). It is significant to note that the effects of interest rates are dependent on the size of the area which is affected by the public debt. If the public debt is confined to a small economy, then the effect on the market interest will be less since the margin will be minimal compared to large economies. On the contrary, if the public debt affects a large area then, the impact on the market interest will be substantial and the efforts that will be needed to curb the situation at the same time will me huge too. Further, the rise in public debts causes the interest charges to increase (Asia Dept, 2014). Consequently, these charges take place in the productive expenditure such as infrastructure. Sometimes, the high interest rates lead to higher taxation which oppresses the citizens. Therefore, is entirely the responsibility of this governments to make sure that all sectors of the economy is running smoothly. http://www.economicshelp.org/blog/5962/economics/main-problems-of-uk-economy/ The increase in public debts may result to sovereign risk whereby the premium goes up. High premiums create a rise in cost of financing which may threaten public finances solvency. As a result, the weight of the increase in the interest rates will be carried by firms and individuals. When significant debts are merged with negative budgetary starting conditions, it will imply a non-linear and an adverse effect of the high debt level on the interest rates (Brown, 1998). Government debts initially faced by small economies impacted on the financial markets in various sectors such as foreign exchange. Foreign exchange is the most and the largest financial market. On average, it trades a volume of approximately $1.5 which makes it superior than all the US Treasure and equity markets combined. Financial markets were deteriorated by the public debt that was faced by the small economies (Batten & Szilagyi, 2011). Public debt increase may lead to a risk of inflation. The more strong the public debt grows; the government may tend to reduce the value of debt by generating inflation. In such a case, the government gives out debts which are brought by the central bank and the purchase is usually mandatory. The money that the government gets from the central bank is used to finance the budget deficit. The supply of the money expands significantly as a result; there is inflation pressure which may cause hyperinflation. Most of hyperinflation is attributed to budgetary crisis which results from negative economic shocks, bad policies and war (Choudhry, 2010). Additionally, budget crisis may deter the government form increasing finances on the capital markets or the government if forced to borrow at high interest rates and this results to public debts. Public debts have the tendency of increasing the disposable income of the current generation while reducing that of the coming generation. Sometime markets can be very excessively over-reliant on so called credit rating or at the same time market over-reliance risk illustrated as (MOR). This can adversely affect domestic debt issuance. By saying MOR is a demonstration of the risk ratings that has the ability to affect bond yields as one from the supply. MOR depends entirely on two factors, that all the rating are embodied within the regulation and the policies of communication which are adopted because of credit rating agencies, therefore in order to reduce MOR ir will be imperative to eliminate or do away with the rating based regulations and at the same time introduce possible elements of liability credit rating agencies communication policies (Dodhia, 2008). http://scottgrannis.blogspot.com/2014_07_01_archive.html For the period of five years now, the volatility of possible financial markets has considerably increased. This sudden upsurge in volatility need to be structural so that it can be regarded as being a negative phenomenon within the operation of high volatility which is both a signal as well as a catalyst of uncertainty whereby the high uncertainty in most cases tend to be a hindrance to resource allocation (Valle & Ugolini, 2001). Looking at macroeconomic perspective, the increase that is caused due to vitality is very significant especially when it has an impact on the foreign debt for the following reasons; the government bonds represent a huge amount of the present financial assets while all the foreign debts related to advanced economics seem to have been increased from 72% up to 110% of the GDP (Nier, 2009). The availability and the ownership of such bonds are always in the hands of small investors, for instance, citizens or voters for the reason that all increased volatility translates to a more higher uncertainty in the wider expectations, this makes it possible to have higher risk in terms of effects to the economy. Volatility associated with the sovereign debt at the same time tend to have an impact to volatility of securities which is issued by the citizen’s corporations and the banking sector (Handbook of liquidity and crises, 2010). And lastly volatility associated with the government bonds may act as stimuli to economic policy responses leading to the greater effects. The equity markets has the ability to give the companies ability of raising much needed capital, this enables the companies to open does for investors to have for opportunities related to investments and in return gain, it allows company’s stock shares trading to be possible. The equity market impact large trades, it is important and common on prices although rarely measured. With an explicit dependence on economical trade durations, volatility, regular volumes and finally shares outstanding,. The outcome can be set aside and incorporated and merged together with optimal measured trade scheduling algorithm that operate closely with the post-trade fee estimations. All transaction costs are commonly recognized as crucial determinant in terms of investment performance. Not only do they have an impact on the active investment strategy, they also control the way assets within the economy converts into cash if at all the need arises. This kind of cost is grouped into two categories (Vandenbussche & Blazsek, 2009). Direct cost which falls under commissions and fees, are clearly stated and simple to be measured. They are crucial and worthy to be minimized. Indirect cost which seems not to be defined or stated especially for large traders. The only crucial component about this is the impact that originates from the trader’s initiated but own actions and the impact created on the market. This cost are difficult to measure but very convenient by improvement through careful trade management According to Folkerts-Landau, Garber, & Schoenmaker (1996), before the 2008 financial crisis, the asset market used to be in liquid and there was ready funding at a convenient low cost, but with emergence of the crisis everything changed drastically and the markets became even worse. This condition forced many institutions to start operating differently regardless of the current capital level, this was due to severe liquidity problems experienced leading to different central banks to step in and take required actions. In order to respond to this Basel Committee for Banking Supervision (BCBS) came up with a draft which had detailed regulatory framework aimed at achieving systematic formula of operation that will not expose the whole banking sectors to any risk again (Rieffel, 2003). Besides the new rules targeting the capital and leverage, same framework had detailed precise short term plan as we as long term plan for liquidity requirements as a very important concept that can be used to reinforce control and resilience in the banking sector for liquidity risk. The equity market investors take an opportunity of trading widely because of the varies products available, for instance, warrants, exchange traded funds as well as exchange traded notes http://www.rba.gov.au/publications/bulletin/2010/mar/7.html Liquidity Coverage Ratio (LCR), this is known to be short term ratio that calls for financial institutions to poses high quality of their liquid assets in order to meet short term responsibilities, this originates from the sudden liquidity disruptions. It is obvious that banks are supposed to hold certain amount aimed at maintaining high liquid assets which is closely equally to available net cash flow for more than 30-day stress period. As the mandate of LCR seems to be straightforward, its exact purpose setup and its potential that is unintended disadvantages due to the side effects sounds to be controversial (Frenkel, Dooley & Wickham, 1989).. LRC initiated and encouraged incentives for the banks to scale down their lending ratio and borrowing in the already unsecured bank to bank money market caused because of run-off assumptions which conditioned banks to start holding large amount of liquidity buffer balancing all outflows. But some observers say that, it is not possible for the direct effect to take place due to LCR scheduled loans that have shorter 30 days only to their maturity which constitute the larger part of all money that is not secured with the interbank markets (Oxley, 2012). Conclusion Public debts has not only brought adverse effects on the financial markets but has also brought sharp economic slowdown in many countries which in return has affected trade balance and the growth of this economies. Additional, it has caused deterioration of finances in most of the advance countries such as United Kingdom, Japan and United states. This situation is attributed to strong and high levels of public debts. In some countries, public debts put them at risk of solvency until level where most of the government institutions and sectors fail to function leading to the total collapse of the main services. Further, the cost related to ageing will increase the problem of sustainability of public finances exaggerated by the low birth rate; this has reduced with great margin the availability of sustainable work force to maintain the economy. To solve this problem, a debt reduction program is required in place, this governments need to initiate policies that are aimed at improving the government targets pertaining debt reduction. This program will be more urgent in the countries that are questionable in the financial markets and those that face high risks of increasing risk premiums. For the countries that are not in such a situation, the adjustments can be made gradually. This program of debt reduction should put more focus on cutting down on public spending. Further, for most advanced countries that are affected, measures that lead to increment of revenue may also be required so as to arrest the situation successfully. On the contrary, the program may slowdown the pace of the economic growth but will eventually have positive results on the public debts. The situation has to be taken care of as soon as possible to avoid the growth in margin of the public debts. Reference ASIA DEPT., I. M. F. M. E. A. C. (2014). Republic of Armenia. Washington, International Monetary Fund. http://public.eblib.com/choice/publicfullrecord.aspx?p=1676618. BROWN, P. J. (1998). Bond markets: structures and yield calculations. Chicago, Glenlake. BATTEN, J., & SZILAGYI, P. G. (2011). The impact of the global financial crisis on emerging financial markets. Bingley, Emerald. CHOUDHRY, M. (2010). An introduction to bond markets. Chichester, West Sussex, Wiley. http://public.eblib.com/choice/publicfullrecord.aspx?p=624740. DODHIA, D. (2008). 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