Money and Capital Markets - Assignment Example

Money and Capital Markets Name Institution Course Professor Date Executive Summary This paper provides a discussion on money and capital markets. This discussion is based on two countries, which are Australia and United States. The paper identifies the trends in interest rates for each of these countries and provides an historical background of such interest rates. The paper also provides a forecast for interest rates for each of the countries. Finally, the paper provides a conclusion and recommendation section, which argues that money and capital markets are essential for all countries. This is because they contribute significantly towards attainment of success of the country. Further, countries have to focus on formulating effective monetary policies, which will ensure that performance of their money and capital markets is effective in the financial markets. Table of Contents Executive Summary 2 Table of Contents 3 Introduction 4 Question 1 5 Australia 5 United States of America 7 Question 2 9 Summary and Conclusion 11 Reference List 12 List of Figures Figure 1: Australia Interest Rate 5 Figure 2: Charts on Australian Interest Rates 6 Figure 3: United States Interest Rate 9 List of Tables Table 1: United States Money Market Interest Rates 1980-2002 8 Introduction Interest rate is regarded as the rate at which a borrower as to pay interest as a result of using money borrowed from a lender (Hicks, 2009). Interest rates targets are critical tools, which are used in monetary policy. As such, interest rates are considered when variables such as unemployment, inflation, and investment in a country are taken into consideration. Reserve Banks or Central Banks of countries may lower interest rates with expectations of increasing consumptions and investments, but these expectations may never be realized since they may lead to attainment of massive economic bubble (Centre for European Policy Studies, 1998). This may develop in cases where excessive investment is availed to stock market and real estate market. Money market is different from capital market. This difference is based on three factors, which are the institutions involved, credit instruments, and maturity periods (Sullivan, & Steven, 2003). With reference to maturity period, capital market involves borrowing and lending of long-term finance while money market involves borrowing and lending of short-term finance. Credit instruments for capital markets include government securities, stocks, bonds, debentures, and shares while money market credit instruments include bills of exchange, collateral loans, call money, and acceptances. Finally, on the basis of institutions, capital market institutions include building societies, stock exchanges, mortgage banks, commercial banks, and insurance companies (Sinha, 2012). Money is regarded as the main medium of exchange. As such, countries have to use money as the exchange means in order to ensure that their citizens are able to prosper and live in peace and harmony (Dodoo, 2008). Based on this, money and capital markets are established as components, which ensure effective exchange between countries. This occurs since capital and money markets bring global financial market into the same platform, which ensures effective interaction, sharing, and exchange of monetary ideas. However, countries have adopted their own mechanisms for ensuring that their performance at financial market is effective (Wiegand, 2000). This mechanism is the adoption of a monetary policy, which a country has to adhere to strictly. Question 1 Australia According to Trading Economics (2012), Australian interest rate benchmark was previously approximated at 3.5 percent. At an historical perspective, Australian Interest Rate since 1990 to 2012 had an average of 5.6000 percent. During this time, the interest rate attained a low record in 2009 April at a percentage of 3.0000 while in 1990 January it attained a high peak of 1.5000 percent (Trading Economics, 2012). Reserve Bank of Australia’s Board is mandated with the tasks of making various decisions as they regard to Australian interest rates. Cash rate acts as the official interest rate for Australia. Cash rate is regarded as the charge rate levied on overnight loans for the various financial intermediaries. The interaction of overnight funds supply and demand creates a money market, which aids in determining the cash rate. Figure 1 and 2 illustrates Australia interest rate for three years. Figure 1: Australia Interest Rate Figure 2: Charts on Australian Interest Rates (Source: Westpac Market Insights. (2012). Institutional Bank. Retrieved from: http://www.westpac.com.au/docs/pdf/aw/economics-research/MarketInsights.pdf) According to Reserve Bank of Australia (2012), the Reserve Bank Board adheres to monetary policy by establishing cash rate targets. This act as the lending and borrowing rate for banks on an overnight, which is regarded as unsecured basis. Such a rate is established by the settlement balances of supply and demand exchanges for commercial banks within the Reserve Bank (Reserve Bank of Australia, 2012). However, the Reserve Bank has the power of altering supply and demand balances in order to ensure that the cash rate remains within the expectations of its target. Moreover, the Reserve Bank is actively involved in operation within foreign exchange market, so that it meets the various demands of its clients, who are mostly the Australian Government. On the same note, the Reserve Bank is involved in the management process of Australia’s international reserves. This includes addressing disorderly market conditions, as well as having an influence in the Australia’s exchange rate level. United States of America In United States, decisions on interest rates are made by Federal Open Market Committee (FOMC) and the Federal Reserve Board of Governors. FOMC makes decisions, which are related to market operations, which include market rates for federal funds and central bank money levels. On the other hand, the board is involved in making decisions, which are related to discount rates changes as they may be submitted by various Federal Reserve Banks (Von Hagen, 1997). In both Australia and United States, interest rates attain different trends based on the economic development of the nation. This includes consideration of Government payments, as well as discounting payments. Unemployment rate is an indicator of economic development in a country. As such, employment rates contribute significantly towards determining the trends of the interest rates (Livingston, 1996). Politics play a significant role in determining the type of trends, which are expected in interest rates. This is because a countries politics determine the type of policy flexibility, which will have to be adopted. Table 1 illustrates United States Money Market Interest Rates. Table 1: United States Money Market Interest Rates 1980-2002 Type 1980 1985 1990 1995 2000 2001 2002 Federal funds, effective rate 13.35% 8.10% 8.10% 5.83% 6.24% 3.88% 1.67% Prime rate charged by banks 15.26 9.93 10.01 8.83 9.23 6.91 4.67 Discount rate1 11.77 7.69 6.98 5.21 5.73 3.40 1.17 Eurodollar deposits, 3-month 14.00 8.27 8.16 5.93 6.45 3.70 1.73 Large negotiable CDs:                3-month, secondary market 13.07 8.05 8.15 5.92 6.35 3.71 1.73  6-month, secondary market 12.94 8.24 8.17 5.98 6.46 3.66 1.81 Taxable money market funds2 12.68 7.71 7.82 5.48 5.89 3.67 1.29 Tax-exempt money market funds2 n.a. 4.90 5.45 3.39 3.54 2.24 0.94 Certificates of deposits (CDs):3                6-month n.a. 8.05 7.79 4.92 5.09 3.43 1.67  1-year n.a. 8.53 7.92 5.39 5.46 3.60 1.98  21/2-year n.a. 9.32 7.96 5.69 5.64 3.97 2.74  5-year n.a. 9.99 8.06 6.00 5.97 4.58 3.96 U.S. Government securities:                Secondary market:4                 3-month Treasury bill 11.39 7.47 7.50 5.49 5.82 3.40 1.61   6-month Treasury bill 11.32 7.65 7.46 5.56 5.90 3.34 1.68   1-year Treasury bill 10.85 7.81 7.35 5.60 5.78 3.84 1.62 Home mortgages:                New-home mortgage yields5 12.70 11.60 10.05 7.87 7.52 7.00 6.43  Conventional, 15-yr. fixed3 n.a. 11.48 9.73 7.39 7.76 6.53 6.02  Conventional, 30-yr. fixed3 n.a. 11.85 9.97 7.86 8.08 7.01 6.56 Key: n.a. = not available 1. New York Federal Reserve Bank rates. 2. One fiscal year return 3. Annual averages. 4. Bank discounts and secondary market closing bids averages. 5. Effective rate (Source: Almanac, D. (2012). Money Market Interest Rates and Mortgage Rates, 1980-2002. Retrieved from: http://www.infoplease.com/ipa/A0908373.html). According to Trading Economics (2012), United States last interest rate benchmark was established at 0.25 %. At an historical perspective, interest rate for United States since 1971 to 2012 has an average of 6.2400 %. The lowest average was recorded in 2011 January at 0.2500 % while the highest average was recorded in 1980 March at 20.0000 %. Interest rates decisions in this country are vested to FOMC, and Federal Reserve Board of Governors. The performance of interest rates as based on the decisions of these two bodies are as illustrated in figure 3. Figure 3: United States Interest Rate Question 2 According to Westpac Market Insights (2012), Australian cash rate is expected to cut during the 2012 December quarter. This will be attained since it is expected that the economy of Australia will grow from 2.75 percent to 3.5 percent by the end of 2012. This growth is anticipated since export and sales volumes are increasing at a steady rate. Mining investment is another factor, which will contribute towards an improvement in the level of economic growth in Australia. On the same note, Australia has adopted policy flexibility, which contributes significantly towards lowering the interest rates for this country. Unfortunately, taking a closer look at Australian domestic economy, it is clear that the sector of household is deleveraging, which means that significant structural changes are expected in this country. On the same note, the fiscal policy of the country is consolidating. These have an impact of contributing towards slow global growth. This depicts that investment in non-mining sector will attain slow growth, there will be selective nature in consumer spending, and there will be a reduction of growth in public investment (Davies, 2002). As the above forces conflict the economy of Australia, substantial growth is expected across states and sectors. At domestic level, the interest rates will be lower, which will support development of a broader economy. Furthermore, policy stimulus will improve global conditions of Australian economy. Most indicators of Australia suggest a growth, which is approximately close to trend overall (Trading Economics, 2012). Moderate employment growth is expected to occur as indicated by the market data. However, in some industries, job shedding is taking place, which has made unemployment rates to remain low. Inflation rates also remain low in Australia. According to Trading Economics (2012), in United States business fixed investment is expected to continue to increase as the household spending rises. This is because there is a depression of the housing sector and inflation is declining. Further, price stability and employment rates are expected to increase in United States. This will occur since United States is experiencing a tremendous economic growth. However, such economic growth may not be to the expected position as global financial markets might induce unexpected challenges. Committee for interest rates in United States has focused on establishing higher targets for interest rate by conforming to the expectations of the monetary policy. This will contribute significantly towards steering the growth of economy. Summary and Conclusion Reserve Banks and Federal Reserves have the ability of altering interest rates in a country. However, such alterations need to be made in an effective manner in order to ensure that economic status of a country is not affected by either increment or decrement of the interest rates. Federal Reserve has the power increase the supply of money, establishing an open-market for buying Treasury bonds and mortgage securities, altering discount rates, and altering interest rates targets (Barrington, 2012). Further, monetary policy of any country has a significant role to play towards the success or failure of money market and interest rate. Trends in interest rates are affected by government deficits, current-account balances, and a country’s history on inflation. These are issues, which all countries have to focus on considering in order to ensure that their money markets and interest rate are effective and efficient. However, these factors have little impact when divergences and developments in real estates in countries are taken into consideration for short-run analysis, but for long-term analysis they make sense. This includes reduction of interest rates by having stable and low inflation, reduction of public deficits, reduction of government deficits, and ensuring that premium risk in interest rates is not high in the country. Both capital market and money market are essential components for each country. This is because they determine the functionality and performance of financial institutions of a country. This includes selling and buying of securities and lending and borrowing of securities. In addition, money and capital markets determine interest rates, which are to be adopted by a country, how funds are to be raised in a country, the functionality of monetary policies, and transfer of money from one financial institution to another. This indicates that the government of a particular country has to focus on ensuring that success is obtained by ensuring that the functionality and performance of both capital and money markets is at the accepted and expected levels. This is essential since money and capital markets use similar tools for market analysis such as the ones, which are used by other markets. These tools are the supply and demand tools. Reference List Almanac, D. (2012). Money Market Interest Rates and Mortgage Rates, 1980-2002. Retrieved from: http://www.infoplease.com/ipa/A0908373.html Barrington, R. (2012). Federal Reserve Updates Including Rates, news and forecasts. Retrieved from: http://www.money-rates.com/fed.htm Centre for European Policy Studies. (1998). Capital Markets and EMU; Report of a CEPS Working Party Davies, G. (2002). A History of money from ancient times to the present day, 3rd. ed. Cardiff: University of Wales Press. 720p. 0-7083-1717-0 (paperback). Reprinted November 2005. Dodoo, J. (2008). Money and Capital Market. Retrieved from: http://www.aiu.edu/publications/student/english/Money%20and%20Capital%20mkt.html Hicks, J. (2009). Markets, Money and Capital. ISBN: 9780521873215. Livingston, M. (1996). Money and Capital Markets,3rd Ed. ISBN: 9781557868848. Reserve Bank of Australia. (2012). Market Operations. Retrieved from: http://www.rba.gov.au/mkt-operations/index.html Sinha, A. (2012). What is the difference between Money Market and Capital Market? Retrieved from: http://www.preservearticles.com/201012281814/difference-between-money-market-and-capital-market.html Sullivan, A, & Steven, S. (2003). Economics: Principles in action. Upper Saddle River,: Pearson Prentice Hall. pp. 283 Trading Economics. (2012). Australian Interest Rate. Retrieved from: http://www.tradingeconomics.com/australia/interest-rate Trading Economics. (2012). United States Interest Rates. Retrieved from: http://www.tradingeconomics.com/united-states/interest-rate Von Hagen, J. (1997). “Monetary Policy and Institutions”, Swedish Journal of Economics. Westpac Market Insights. (2012). Institutional Bank. Retrieved from: http://www.westpac.com.au/docs/pdf/aw/economics-research/MarketInsights.pdf Wiegand, Ch. J. (2000). How Big is the World Bond Market?, Salomon Smith Barney Economic & Market Analysis Read More