Capital Markets and Investments - Central Bank Influence on Interest Rates - Assignment Example

Question Central bank influence on interest rates Monetary policy influences different economic factors and this policy is managed and controlled by the central bank. Currency control and money supply management are the key techniques of central banks to set monetary indicators. Central bank changes these supply that in turns influences the economic indicators positively. Interest rate is one of the tools that the center bank uses to manage the monetary policy. Some of the major economic concerns of central banks are controlling GDP, price stability of the money supply and inflation of the country. Central bank also uses the monetary policy to manage unemployment rate and to maintain economic stability in the country (McPhee, 2013). One of the key strategies of central banks including Fed is to manage the interest rate as it allows controlling the GDP and in turn helps in attracting investments (Cooper and John, 2012). By means of imposing monetary policy, central bank imposes an interest rate on the money, which influences the demand of the money in the economy. This leads the central bank to control GDP and other economic indicators in favor of country’s economy (Lien, 2012). Another important reason to set interest rate according to the need of the country is that interest rate is the main factor that provides investors reason to move money from one country to another country. For instance, developing countries set a higher interest rate in order to attract more investments. So this attracts more investors as they invest in such countries with the intention of getting higher returns. Moreover, when interest rate goes high by central bank, it increases the price of borrowing and control inflation and labor market. While, countries facing recession cut down interest rate which reduces the price of the money and leads to increased returns. This in turn increases the quantity demanded within an economy and thus results in changing the GDP (McPhee, 2013). Stabilizing price and currency value is a major reason of announcing aligned interest rates according to the requirement by the central bank. Real interest rate, on the other hand, has a direct relation with the nominal interest rates. Fisher equation shows that real interest rate is almost equal to the nominal interest rate minus inflation (Federal Reserve Bank of San Francisco, 2003). In other words, it can be explained as real interest is the amount of the return that an investor expects to get after eliminating the impact of inflation on the whole transaction. The policies of the central bank influences the short term and long term nominal rate and this impacts the real interest rate which in turn leads to the changes in the economic activities. So, a direct and positive impact on investment occurs. This can be explained as if the real interest is less than nominal interest rate, then investment will increase in the country. Less real interest rate encourages people to purchases more assets or invest more with the perception of long term returns. Thus, it assists in increasing economic activity. If the real interest is higher than the nominal rates, the borrowers avoid borrowing for investments as the returns are less than the costs. Fed announces monetary policy and this influences the short-term and long term interest rates. Long-term interest rate means the interest rate on asset with maturity period of at least one or more years. Asset’s rate,when calculated, is highly dependable on the short term rate set by the central bank. This is an evidence that the central bank influences on the maturities’ long term interest rate (Lien, 2012). Although researchers have suggested that the fed has no clear impact on the long term interest rate, but nominal short term rates provide the grounds for long term rate. Although Cooper and John (2012) suggest that the Fed’s policy impact on long term interest rate and real rates are not perfect, however it provides a ground for the decision regarding money transactions and asset maturity (Cooper and John, 2012). To sum up the discussion, it can be concluded that central banks have purpose of controlling money supply of the country, other currencies and positively shaping the investment and borrowing decisions in favor of the economy of country.The major tool used for the purpose is nominal interest rates that are announced by central banks for short-term. This then makes an impact on the long-term interest rates on the purchasing and selling decision of long-term assets having maturities of one or more years. Further, the nominal rate announced by central bank impacts the real interest rates. There is a cautious procedure of central banks to influence overall borrowing and lending decisions via control on the flow of money by means of applying interest rates. Question 3 Price fluctuation of copper in 2015 Copper is one of the early metals human found. It is used for different purpose in day to day activities. Major consumption of copper is in electronics, automobiles, conductors and construction industry. Copper is an important trade element globally. As other commodities, copper also faced the economic rises and fell with the world’s recession and booms. The commodity price forecasts suggested a vital percentage change in the prices of the copper. In 2014-2015, the change of copper was -6.3% whereas in 2013-2014, the change was 1.4% (World Bank, 2014). Further, 60% of the producer believes that the prices of copper would continue to decline in the next 12 months. Other, 20% of the producers think that the price will remain averaged. However, the remaining 20% thinks that the prices will rise (PwC, 2014). The given facts build the perception of high fluctuations in the prices of selected commodity. (Investment Mine, 2014) Further, if the history of five years prices of commodity is analyzed, then it can be found that the till 2011, the prices were fluctuating but showing an increase. However, after 2011, the prices started declining, but then after 2013, the prices have become somewhat stable. With global economic growth, the demand of the commodity is increasing at a rapid pace. This demand is particularly high in the developing economies. Although, economic development is increasing the demand, however the copper industry is continuously facing the decline in prices due to many reasons. According to the economists, one of the main reasons is a surplus of production. The other reason is economic balancing reforms of China. Previously, China was the major consumer of Cooper, however there are doubts about high demand of copper in China. Thus, this will influnece the price of Cooper (Business Recorder, 2014). Pettis (2012) suggests that most of the increased demand of the product in last two decades was due to imbalance high growths of production in China. This growth is now stablized and is more of a steady growth and this has lead the prices of copper to decline (Pettis, 2012). Analyzing the prices of copper in 2014, analyst found the prices went down by 0.2% to the last forecast and 6% percent down as compared to 2013. This suggests that the high volatility in the prices of commodity. Market surplus is considered as a major factor to forecast the declines in the price. Moreover, analysts are skeptical about the impact of demand rises and falls in the upcoming year. These factors will lead the price changes accordingly. Further, economists are in favor of the increase in demand from China and property industry for the fourth quarter of the year 2015 to lead prices towards positivity (Business Recorder, 2014). Main factors impacting on high fluctuations The major factors influencing the price fluctuations of the commodity are Surplus in production, dropping demand trends and controlling demand by laws in China, and inventory piles. Surplus supply The dramatic increase in the demand of the commodity in last decades has not helped the producer to forecast the demand properly. The reason is that because of optimism of high growth, producers have started to produce more which will continue for years more. (Kitco, 2014) Looking at the given trend, it is evident that surplus of supply is making the prices decline. Costs of production are of high concern of the producers as high cost of keeping and transporting the product is leading towards selling of at lower prices. Now producer and governments are embedding seize in the production to control the surplus of supply (Kitco, 2014). China- dropping demand and piled up inventories China is consuming 40% of the total produced copper. China was the main reason in the increased production of the copper and now, China is one of the main reasons of the fluctuations in demand and price trends. China recognized its imbalances in economic growth and started to tighten the policies of credit and raw material demands. Further, China’s inventory currently seems sufficient to control the demand from the market. The trend below reveals the decline of metal import in China for last three years. (World Bank, 2014) According to Business Recorder (2014), there will be less growth in the China’s economy for some more years and this will keep the demand in control and continue to hurt the prices of copper (Business Recorder, 2014). Particularly economists suggest that for the next year the seasonal demand is vital for the continuity of good prices in the market. Further, now copper analysts optimistically judge the situation and see the demand increase of copper from other countries except China. It has been suggested that the long-term growth of industry is vital and can sustain the impact of short term falls in demand and price declines. Finally, economists believe that global growth recovery is forecasted in 2015 (Gilcrest, 2014). Fluctuating trend of prices in upcoming years and this trend can be assessed in the graph below. (Kolesnikov, 2014) Question 4 Fundamentals related to Share price Share price of a stock in capital markets is determined mainly by demand and supply of shares. The demand and supply of shares are determined by the number of investors intended to buy and sell shares of the company. The demand and supply of shares of a company in the capital market are influenced by a wide number of factors. For example, information about the operations of the company, management related information, sentiments of the investors and most importantly, the recommendations of the analyst about the company are important factors. Role of the analyst is considerably important. Analysts make recommendations of the various scales such as a strong buy, buy, hold, sell, neutral, underperform, and sell. Based on these recommendations made by the analyst, most of the investors make investment decisions (NASDAQ, 2014). The impact of analyst recommendations also has an impact on the performance of share price in the stock market as well. For instance, empirical evidence of the Public Companies in Brazil were assessed and results revealed that analysts’ individual recommendations produced favorable results in the first month while consensus recommendation did not perform well (Martinez, 2010). Variation in the analyst recommendation is the result of the various techniques used and analyzed by various analysts differently. Broadly, analyst used fundamentals as well as technical charts for the recommendations. Role of fundamentals is of critical importance at this point. Various analysts use different fundamentals for developing future forecasts of the share price of a company. Fundamental referred by the analyst includes almost all information produced in the financial reports of the company. In addition to the quantitative information produced in the annual report such as sales, profits, cash flows, depreciation, interest expense, dividends, and earnings, analysts also refer to other information such as industry growth, competitors pressures and so on. In addition to this, some of the widely used fundamentals for valuing share includes: Earnings Per Share Earnings per Share are the amount declared as profit for every shareholder in the company. As it determines the profit of shareholder in the total profit of the company, it is used by analyst to make are commendation to investors for their increasing or decreasing value of invested amount in shares. Earnings per share are also useful in valuing other fundamentals. For instance, dividend per share and per earnings ratio that entails share received by the investors and price investors are ready to pay for per unit of investment respectively. For example, growth in P/E ratio entails bright future prospects where investors are ready to pay a high price for every unit of earning.  Moreover, EPS trend is also declared as a determinant of the future profitability of the business, investment requirement of the business. Dividend and Dividend Yield Dividend announced and/ or paid by the company carries critical fundamental information that is immensely used by analyst in defining share price. Investors with need of theregular stream of income used dividend as an important fundamental.Analysts also uses dividend in Gordon Brown model for the price determination. Price to Book Ratio  Analysts also use price to book ratio as an important fundamental to determine share price. It provides information about value that investors will be paying for the book value of the assets of the company and is valuable information mainly to consider the worst case of bankruptcy. Hence, change in the book value of the company with a change in value of Price of Book ratio that in turn will change the share price determined by using this ratio, Returns on Equity: As a matter of fact, analysts highlight position of all returns; however, return of equity is widely used as share price is the determination of the price of equity. ROE provides information about the profits generated by firm, leverage of the firm as well as returns that investors are receiving. Hence, fundamental have a notable role in the price determination of shares. However, it is noteworthy that despite using similar fundamentals analyst recommendations vary. The reason behind this fact is that different analysts anticipate and perceive each fundamental differently; hence, different prices are forecasted by different analyst vary. Impact on share price as a result of analyst recommendation based on fundamentals is also affected by the expertise and the reputation of the analyst (US SEC, n.d.) References Business Recorder. (2014). Supply to flood copper market in 2015, weighing on prices. Available from http://www.brecorder.com/general-news/172/1239524[Accessed 3 December 2014] Cooper, R., and John, A. (2012). Theory and Applications of Economics. Available from http://2012books.lardbucket.org/pdfs/theory-and-applications-of-economics.pdf[Accessed 3 December 2014] Cooper, R., and John, R. (2012). Theory and Applications of Economics. Creative Commons Federal Reserve Bank of San Francisco. (2003). What it the difference between the real interest rate and the nominal interest rate?. Available from http://www.frbsf.org/education/publications/doctor-econ/2003/august/real-nominal-interest-rate[Accessed 3 December 2014] Gilcrest, L. (2014). Analysts bearish on copper price in 2014 on supply, China demand. Platts, Available from http://www.platts.com/latest-news/metals/washington/analysts-bearish-on-copper-price-in-2014-on-supply-21622188[Accessed 3 December 2014] Investment Mine. (2014). 5 Year Copper Prices and Price Charts. Available from http://www.infomine.com/investment/metal-prices/copper/5-year/[Accessed 3 December 2014] Kitco. (2014). Multi-Year Global Copper Market Outlook. Available from http://www.kitco.com/ind/Hamil/2014-06-19-Multi-Year-Global-Copper-Market-Outlook.html[Accessed 3 December 2014] Kolesnikov, I. (2014). Commodity Prices Forecast 2013-2018 | Charts and Tables. Knoema, Available from http://knoema.com/wxgcxde/commodity-prices-forecast-2013-2018-charts-and-tables#Copper%20(US%20cents%2Flb)[Accessed 3 December 2014] Lien, K, (n.d.). Why Central Banks and Interest Rates are so Important.Yahoo! Finance, Available from http://finance.yahoo.com/education/currencies/article/106078/Why_central_banks_and_interest_rates_are_so_important[Accessed 3 December 2014] Martinez, A. L. (2010). Analysts’ recommendations and stock performance: an empirical study of brazilian public companies. McPhee, S. (2013). How Central Bank Actions Influence Currency Rates.Shares Investment, Available from http://www.sharesinv.com/articles/2013/02/13/how-central-bank-actions-influence-currency-rates/[Accessed 3 December 2014] NASDAQ. (2014). Analyst Stock. Available from http://www.nasdaq.com/quotes/analyst-recommendations.aspx[Accessed 3 December 2014] Pettis, M. (2012). By 2015, Hard Commodity Prices Will Have Collapsed. Business Insider, Available from http://www.businessinsider.com/by-2015-hard-commodity-prices-will-have-collapsed-2012-9[Accessed 3 December 2014] PwC. (2014). Miners adjust to volatile commodity markets. Available from http://www.pwc.com/ca/en/mining/publications/pwc-global-gold-price-survey-results-2014-11-en.pdf[Accessed 3 December 2014] US SEC. (n.d.). Analyzing Analyst Recommendations. Available from http://www.sec.gov/investor/pubs/analysts.htm[Accessed 3 December 2014] World Bank. (2014). Commodity Markets Outlook. Available from http://www.worldbank.org/content/dam/Worldbank/GEP/GEPcommodities/commodity_markets_outlook_2014_july.pdf[Accessed 3 December 2014] Read More