Taiwan: Financial Instruments and Financial Markets - Case Study Example

Business Memo To, Prof. Jerry Kelly Taiwan: Financial Instruments and Financial Markets Introduction Interest rates and other financial instruments or financial markets wholly can have a significant influence on a nations’ economic growth. Relatively, Taiwan was less affected by the 2008 global financial recession whereas many European countries and the United States were severely affected by the recession. This memo tends to analyze how interest rates, financial instruments, and financial markets in Taiwan are different from those in the United States. Interest rates, financial instruments, and financial markets Interest rates, financial instruments including various monetary tools, and financial markets constitute a nation’s economic policy. The way a nation uses these tools determines the nation’s growth rate and vulnerability to global economic shocks. The following sections will give a detailed view of financial market characteristics of both Taiwan and the United States. 1. Bond markets Taiwan’s bond market is characterized with many contradictory tendencies. Although the overall Taiwanese bond market is Asia’s second largest, often the volume of trading is extremely small. Evidences indicate that the economy’s bond markets experience tremendous liquidity when interest rates fall. When interest rates increase, security houses stop trading and this situation causes liquidity level to fall nearly to zero. Hence, interest rates play a central role in determining Taiwan’s bond market trends. The US bond market is one of the world’s largest markets and it includes government, municipal, asset backed, financing, and corporate. Although returns from bonds are relatively low, the level of risk is minimum in the US bond markets. While evaluating US bond markets, it seems that they are currently struggling with huge amounts of debt. US bond market rates are expected to fall or remain low in the coming years. 2. Sovereign debt rating Sovereign debt rating assists a country to identify its likelihood that it would fail to repay its loans. Fitch, Inc, a British rating agency, gave an A+ rating for the Taiwan’s long term credit. The agency opines that the economy’s huge reserves would benefit it to effectively manage risk factors even though it has not been recovered from the recent recession yet. The Fitch specifically points out low debt level of Taiwan and the agency argues that this condition would protect the Taiwanese economy from a potential cash shortage (“Taiwan gets ‘A+’ sovereign debt rating from Fitch,” par. 1-3). Similarly, the Fitch retains United States’ AAA (highest investment grade) rating even though the economy holds a negative credit outlook. According to the agency, a “highly productive, diversified, and wealthy economy” assisted the United States to retain its long term debt rating (“Fitch retains ‘AAA’ rating for US: Outlook negative,” par. 1-4). A better status of the dollar also contributed to this rating Commercial paper markets “Commercial paper is a type of fixed-maturity unsecured short term negotiable debt issued generally in bearer from and primarily by non-banks” (Bank for International Settlements, par. 1). While analyzing the Taiwanese economy, it is observed that transactional commercial paper is not so popular in the country’s commercial paper market and hence this instrument represents only a small percentage of commercial paper transactions. In contrast, financial commercial paper is highly active in the Taiwanese commercial paper market. Currently, the economy’s commercial paper market is achieving increased level of fluidity and is less prone to fraud or manipulation. The US commercial paper market remains to be one of the most developed CP markets in the world despite the severe global recession. The US CP market suffered a drastic contraction during the 2001-2002 periods. Financial forecasts indicate that the US CP market is expected to grow slowly over the coming years. 3. Stock markets Taiwan’s two major stock exchanges are The Taiwan Stock Exchange (TSE) and The Gre Tai Securities Markets (GTSM). As of 31st May of 2007 (as qtd. in Longo), the TSE comprised of 680 listed companies with a total market capitalization of NT$20.2 trillion whereas there were 533 listed companies in GTSM with a total market capitalization of NT$2.17 trillion (89). The country’s stock markets performed better during the last few months. The US stock market is formed of stock exchanges, off exchange markets, and OTC markets. The global recession caused many changes to the US stock markets and it is expected that the structure of the US stock markets would undergo tremendous changes over the next decades. Currently, international stock exchanges have integrated with US exchanges in some areas. US stock markets could not regain its momentum after the recent recession. 4. Derivative markets Taiwan’s derivative market is still at its development stage as compared to its peers. Market trends indicate that foreign hedge funds particularly focus on the country’s derivative market. Relatively, level or legal regulation is high in the Taiwan’s derivative market. Although the nation’s derivate market growth lags behind other countries, it is predicted that Taiwanese derivative market would become a key international derivative market in the near future. The 2008 global financial crisis led to the collapse of US derivative market, which was one of the world’s largest derivative markets. The US housing boom also contributed to the failure of the US derivative market. When the Taiwanese derivative market is well positioned to promote growth, the US derivative market has to be rebuilt to regain its growth momentum. 5. Stock market indices Companies traded on the Taiwan Stock Exchange use a stock market index called Taiwan Capitalization Weighted Stock Index; and similarly, GTSM index is a capitalization weighted index used by companies that are traded on The Gre Tai Securities Markets (TWSE, par. 8-10). In contrast to this, a variety of stock market indices are used in the United States. US stock market indices are categorized into Amex indices, CBOE indices, Dow Jones & Company indices, Goldman Sachs indices, MSCI indices, NASDAQ indices, Russell indexes, Standard and Poor’s indices, Value Line Composite Index, Wilshire Associates indices, and the Capital Markets Equity Index (“List of word stock market indices,” par. 4-13). However, US’ three major stock indices are NASDAQ Composite, S&P 500, and Dow Jones Industrial Average. 6. Foreign exchange markets Taipei foreign exchange market addresses entire foreign exchange transactions of authorizes foreign exchange banks and offshore banking units. According to Central Bank of Republic of China, total net trading volume in the Taipei foreign exchange market was US$575.1 billion as of May 2012 whereas the average daily turnover amounted to US$26.1 billion. Transactions between banks and customers represented 24.8 percent of total transactions and the remaining 75.2 accounted for interbank transactions. (Central Bank of Republic of China, par. 1). In the case of the United States, the foreign exchange market makes up a notable portion of the US economy and this market sector is a potential revenue source for the country. Currently, US dollar is the most accepted base currency in the global foreign exchange market. According to financial data (as qtd. in Shankar), US foreign exchange market has an average daily turnover of US$664 billion whereas it is US$607 billion in the case of foreign exchange derivative market (7-8). 7. Factors affecting currency demand While analyzing the Taiwan’s financial market, it seems that inflation rate and unemployment rate greatly affects the demand for Taiwan’s currency. Despite recessionary issues, the economy keeps a relatively low inflation rate as well as unemployment rate. In addition, the country has an improved trade surplus; furthermore, Taiwanese foreign reserves are the fourth largest in the world. These positive factors enhance the demand for new Taiwan dollar. A huge trade deficit significantly drives demand for the US dollar. The huge trade deficit figure makes foreign investors nervous and hence this condition adversely affects the US dollar demand. However, recent data show that trade deficit is declining and this condition gives scope to US dollar. As mentioned earlier, the recent global recession dreadfully affected the US economy and led to a series of bank failures in the country. Hence, a weaker economic environment lessens the demand for US dollar. 8. Factors affecting demand for various financial instruments Undoubtedly, Taiwan’s stable economy influences demand for various financial instruments like bonds, commercial paper, stock, and derivatives. As the economy has a higher growth potential, global investors are interested to make trade relations with Taiwan. Evidently, increased rate of trade transactions would enhance the demand for various financial instruments. Unlike Taiwanese economy, the US economy still struggles with the adverse effects of recent global recession. Those recessionary issues limited the US economy’s ability to invest in productive purposes. In other words, the recession notably impeded the country’s economic growth. Naturally, such a slow growth condition limits the demand for financial instruments like commercial paper and bonds. Taiwan’s financial markets Taiwan’s financial market is still young as compared to other countries. However, the country’s financial markets have higher growth potential and this favorable condition makes Taiwan one of the best global destinations for investment. Hence, the country has access to numerous potential financial sources. In short, it can be stated the Taiwanese economy is in its way of rapid economic development on the strength of its potential financial markets. Conclusion In total, Taiwanese economy is likely to grow more than the US economy over the next decades once the 2008 global recession has dreadfully affected the US economy. Even though Taiwanese economy is much lower than that of US economy in size, it (Taiwanese economy) remains unaffected by global economic shocks. Works Cited Central Bank of the Republic of China (Taiwan). “Taipei foreign exchange market May 2012.” Press Release. (2012). Web. 14 July 2012. Bank for International Settlements. “Commercial paper markets: A survey.” (1993). Web. 14 July 2012. Longo, John M. Hedge Fund Alpha: A Framework for Generating and Understanding Investment Performance. London: World Scientific Publishing Co, 2009. Print. “Fitch retains ‘AAA’ rating for US: Outlook negative.” (2012). Web. 14 July 2012. Shankar, Daya. “Developing countries, foreign direct investment and the US dollar as a central currency.” Global Forum on International Investment (2008): 1-48. Web. 14 July 2012. Taipei Times. “Taiwan gets ‘A+’ sovereign debt rating from Fitch.” (2001). Web. 14 July 2012. TWSE. “Guide to investing in Taiwan.” (2005). Web. 14 July 2012. “List of word stock market indices.” (2008). Web. 14 July 2012. Read More