Financial System and Economic Growth - Assignment Example

Financial System and Economic Growth (Name of Student) 333-101 Finance I (Name of Professor) August 17, 2007 ASSIGNMENT 1 QUESTION 1: Lectures have several times proposed that an efficient financial system is important to economic growth. Discuss why this might be true (or not) by reference to an example of how the financial system promotes economic growth. Answer: It is true that an efficient financial system is an important factor in economic growth. There is empirical evidence showing the direct relationship of efficient financial system to economic growth of countries. A study conducted by Goldsmith that covers 35 countries during the period 1860 to 1963 revealed that “financial development accelerates growth” (Thiel, 2001, p. 20). Subsequent studies also illustrate the empirical analysis of variables using factors for economic growth such as gross domestic product (GDP) as dependent variables with financial factors such as bank financing and stocks as independent variables. It resulted to prove that efficient financial system is necessary to promote economic growth. Direct Relationship between Availability of Loans and Growth of GDP Availability of capital through bank loans spur enterprise activity in the economy resulting to higher products and services produced subsequently affecting the rate of GDP that measures the growth of a country’s productivity. Thus, the higher the number of goods and services produced will more likely generate employment thereby increasing the ability of households to save money from their disposable income. Higher savings of household deposited in banking institutions further increases the supply of capital in the economy making it widely available at a cheaper price hence subsequently affecting the overall growth of the economy. Strong Stock Market Increases Financial Stability among Firms An efficient stock market where shares of firms are traded helps solidify the overall stability of firms given the regular flow of capital into their operations which further strengthen and increase their market outreach leading to competitive prices and services for consumers. Competitive prices allows for increase in purchasing power of consumers not to mention increase in product choices at affordable prices, hence, strengthening consumer demand. Firms can also use the additional capital from purchase of their stocks to improve manpower and technological enhancements in their operations leading to higher level of skilled human resource. It eventually helps strengthen the human resource sector of the economy making it competitive in international market. Increase demand for local human resource from the international market gives the opportunity for higher currency remittances resulting to increase in money supply. Availability of money within the economy further lowers interest rates for bank loans and to a certain extent helps strengthen the currency of a certain country. A stable currency means lower cost of importations particularly for companies providing basic services like electricity and telecommunications. It means lower cost to household expenses increasing their opportunity for savings. The Sydney Morning Herald in its business article entitled Two Sides of the Nation’s Rising Prosperity pointed out that “ the greater importance of the financial economy is that, as financial market become more developed, the stock of assets is increasingly acquired by borrowing” (Gittins, p.1) which increases the choice of credit source of firms and individuals aside from banks. It helps lower cost of borrowing making it more affordable and accessible for small enterprises to spur their growth in the economy. Direct Relationship of Selling Government Bonds to Increase in Social Services Government sells bonds to the public to generate money to spend for its social projects such as construction of roads, schools and hospitals, installation of water and electricity system, and availability of hospitalization and medical benefits, among others, to the public particularly for those areas where infrastructure and basic social services are lacking. An efficient financial system networks the selling and purchase of these government bonds to ensure reputable sales showing the public that indeed the government can pay off its debt. This trust is crucial for a well placed financial system particularly among banks and other financial investment companies that support this kind of financial transaction by making it one of their financial products. Financial markets channel funds across individuals and firms to generate or spur economic growth. These entities actively participate in the financial activity in the market such as putting their savings in banks or investing it in investment companies or businesses if there is an efficient financial system that they can rely on. Stable interest rates, currency and stock market are necessary factors that build trust for the financial system that result to higher participation in the financial activity of the economy. Hence, it is important that every government ensures to stabilize their financial systems to deliver these results. Economic growth only proceeds when firms and households participate in the financial activity of the economy. This can only be done when they have full faith in the financial system. QUESTION 2: Assume you have decided to buy an apartment in Carlton as an investment and need to borrow $300,000 for ten years. What will be the optimum source of these loan funds? Briefly describe the costs and advantages of your preferred loan source. Part of the capital of $300, 000 for purchasing an apartment in Carlton can be sourced out from Westpac Banking Corporation. It is ranked as one of the “top 10 listed companies by market capitalization on Australian Stock Exchange Limited” (Westpac). The following table shows the amount of repayments, interest rates and upfront costs of the loan under the 10 Year Fixed Investment Loan Product of Westpac. COSTS AND TERMS Loan Features Amount of Repayments (Inclusive of fees & charges) Upfront Costs Fixed Investment Loan Product Purchase amount: $ 300, 000 Loan amount: $ 285, 000 Interest rate: 7.89% per annum Repayment Period: 10 years Monthly - $3, 623 Fortnightly - $ 1,670 Weekly - $ 835 Deposit Equity : $ 15,000 Government Charges: $ 9, 767 Mortgage Insurance: $ 4,586 Loan Establishment Fee: $ 750 Estimated Legal Fees: $ 600 Total Upfront Costs: $ 30, 703 Source: Westpac Home Loan Center Calculators Government charges already include stamp duty on purchase, registration of title transfer and registration of mortgage. The borrower will not worry spending for these items when processing the documentary requirements for ownership of the apartment. The loan amounts to less than $300, 000 since the borrower will put up an equity amounting to $ 15,000, with mortgage insurance. The latter is important in case the borrower opts to borrow more money in the future against the property. Though, it increases his upfront costs, the trade off is the opportunity in the future to borrow higher amount of money against the property. References Thiel, M., (2001), Economic Paper. Finance and economic growth- a review of theory and available evidence, 158, p. 20. Retrieved August 15, 2007 from Europa.eu databaste. Gittins, R. (2006, December 23). Two sides of the story of nation’s rising prosperity. The Sydney Morning Herald, p.1 Westpac Banking Corporation. (2007). A brief overview of Westpac Banking Corporation. Retrieved August 15, 2007, from http://www.westpac.com.au/internet/publish.nsf/Content/WICP+Company+profile Westpac Banking Corporation (2007). Westpac Home Loan Center Calculators. Retrieved August 15, 2007, from https://hlc1.westpac.com.au/hlc/hlc/Splash.do?referrer=Public Read More