Financial Markets and Institutions
The New York Stock Exchange
A financial market refers to any market where the purchase and sale of securities take place. An example of the financial markets includes the stock exchange, where publicly listed companies’ purchase, sell, and stock issuance occur. The New York Stock Exchange (NYSE) is one of the world’s most prominent stock exchange markets (Tretina, 2021). NYSE includes some of the largest and oldest US companies and is recognizable worldwide. Our assignment writing help is at affordable prices to students of all academic levels and academic disciplines.
NYSE operates five equity markets across the country. NYSE is three times larger than the next stock market in terms of liquidity. The entity also has the narrowest bid options globally. As the global financial markets keep evolving, NYSE has continued to develop innovative partnerships, trading techniques, and effective technology to allow international trading.
The stock exchange market supports both online transactions and the use of brokers as its main transaction methods. All transactions at NYSE are auctions regardless of the transaction method used (Tretina, 2021). The NYSE operates seven liquid markets, thus allowing investors to access stocks, bonds, and exchange-traded funds.
The two primary functions of the NYSE include providing a central marketplace for the sale and purchase of stock and allowing companies to raise capital by listing their shares. Traditionally, buyers had to physically meet at the NYSE trading floor, conduct a transaction, and then report it to the exchange. However, with the adoption of the electronic system, buyers and sellers are matched in real-time without interacting physically.
Factors That Affect Interest Rates
The interest rate is the lending rate or deposit rate, which is the amount charged on loans extended to borrowing clients and money saved by clients. Interest rates are intermediate borrowers and savers (Janda & Zetek, 2014). On the one hand, if interest rates are high, savers will be incentivized to save more since there will be more returns in the end. On the other hand, high interest rates will discourage borrowers from taking loans, increasing production costs and reducing returns for investors. Critical determinants of interest rates include savings, investment, prices, and inflation.
One of the factors that determine interest rates is the demand for money. As an economy grows, the need for money in the economy rises automatically. People are likely to seek credit facilities to pay for mortgages and buy new cars. However, if the economy is not doing well, companies avoid credit facilities since their products may not sell well. Consumers are also looking into spending less money if the economy is doing poorly. The result is that interest rates will fall as no people are willing to take loans.
Another macroeconomic factor and the most important determinant of interest rates is the inflation rate. As a result of the impactful relationship between inflation and interest rate, the US Federal Reserve (Fed) uses the federal funds rate as a tool to control inflation. For instance, if inflation is high, the Fed increases the federal funds rate, thus increasing interest rates. High interest rates incentivize savers to increase their savings, thereby reducing monetary flow in the economy.
Ease or Difficulty of Forecasting Interest Rate Changes
Investors are interested in forecasting interest rates, but this has, over time, proven to be a difficult task. However, applying macroeconomic theories can help predict interest rates since macroeconomic trends drive long-term interest rates. One such trend that drives interest rates is the trend relating to inflation and the equilibrium real interest rate. Predicting interest rates over a long period tends to bridge the gap between the current interest rates and the long-term macroeconomic trend (Summers & Rachel, 2019). Therefore, understanding the macroeconomic trends helps in understanding and forecasting interest rates, but not exhaustively.
The difficulty of predicting interest rates arises from two factors that characterize their change over time. First, like many other financial variables, interest rates are characterized by excess volatility due to day-to-day changes in the money market. The ever-changing investor sentiments cause excess volatility due to a constant stream of new economic data and related news (Summers & Rachel, 2019). Another reason for the difficulty is the tendency of interest rates to fluctuate around an average. A good example is The Great Depression in the 1970s, when interest rates rose significantly (Summers & Rachel, 2019). Ever since, there has been a constant decline, a factor that reinforces their unpredictability.
However, as stated earlier, the trends are predictable based on three key economic trends. For instance, the nowcast feature gives crucial data relating to the interest rate series based on data revisions and publication lags. Besides, the series’ long trend on when the fluctuation ends can give crucial leads. Finally, the nature of the transition from current to new levels in the future also provides vital data. As a result, forecasting is based on answering such heuristic questions, which reduces the accuracy of the results.
The Federal Reserve
Before the formation of the Federal Reserve, the US was plagued by financial crises. In some instances, such concerns led to panic, pushing people to rush to their respective banks to withdraw their deposits. A mistake by one bank would cause a domino effect across the financial market, driving people to withdraw deposits even from banks that were doing well. There was a need for a central reserve whereby banks would deposit funds, such that even if “panic” occurred and people withdrew deposits in haste, banks would still survive (Wells, 2017). A 1907 severe panic especially led to Congress’ enactment of the Federal Reserve Act, which effectively led to the formation of the Fed (Wells, 2017). However, the Federal Reserve’s role has expanded since then and now includes safeguarding the economy and ensuring healthy banking.
The Federal Reserve plays a crucial role in controlling and managing the US economy. First, such critical responsibility is setting interest rates. The Fed requires commercial banks and other financial institutions within its control to maintain a pre-determined reserve. Banks that fall behind can borrow from industry peers and refund based on the federal funds rate controlled by the Fed (Wells, 2017). The Fed uses the tool (federal funds rate) to control inflation and achieve desirable employment levels.
The Fed also monitors and supervises commercial banks and other financial institutions within its jurisdiction. The supervisory role is achievable through the Fed’s Board of Governors, which sits regularly and sets a policy framework that complies with the current laws (Wells, 2017). The Fed examines commercial banks regularly to ensure they comply with the established laws. Banks that fail to comply must come up with corrective measures.
Recently Adopted Monetary Policy
The COVID-19 pandemic led to an economic downturn as most businesses closed, leading to high unemployment levels and myriad other financial challenges. The Fed has since responded with an array of actions to hasten recovery. One of such actions includes a massive $2.1 trillion in lending to households and businesses.
However, the most notable monetary policy is the zero-rating of interest rates. At the start of the pandemic, the federal funds rate was 1.5%, but it has since dropped to between 0-0.25 per cent (Lilley & Rogoff, 2020). Cutting the federal funds rate is meant to reduce the cost of borrowing, thereby supporting households and businesses in acquiring affordable loans. Additionally, having learned from the 2007/2008 recession, the Fed provided “forward guidance” that interest rates will remain low until the country achieves economic recovery (Lilley & Rogoff, 2020).
Strategy for the Use of Bond Markets
Long-term and short-term bond investment decisions depend on one’s investment objectives, tax status, investment objectives, and willingness to risk. For instance, a firm intending to earn interest and retain the principal payment should adopt the buy-and-hold option. In this case, the firm will garner interest payments, which usually come twice a year, and the principal amount when the bond matures (Agarwal & Naik, 2001). The principal payment will be less than the principal amount invested if the bond’s coupon payment is less than the current interest rates.
The investing firm using the buy-and-hold strategy should not be worried by the fluctuating market value of the bond nor interest rates. As long as the bond is held till maturity, returns are based on the conditions during initial investment. However, the firm cannot reinvest the bond in a higher market if it decides not to sell it (Agarwal & Naik, 2001). That means the best option is to withdraw it at maturity. Besides, callable bond options are not advisable when using the buy-and-hold strategy since one will be forced to reinvest the principal interest on a low-rate market.
There are other factors a firm investing in this option has to consider. First, the bond coupon interest rate determines the bi-annual interest payments. Also, the yield to call/maturity determines the returns (the higher the yield, the higher the risks). Finally, if the firm is risk-tolerant, they should consider investing in bonds with a low credit rating since they bring more returns.
References
Agarwal, V., & Naik, N. (2001). Characterizing Hedge Fund Risks with Buy-and-Hold and Option-Based Strategies. Working Paper.
Janda, K., & Zetek, P. (2014). Macroeconomic factors are influencing interest rates of microfinance institutions in Latin America and the Caribbean. Agricultural Economics, 60(4), 159-173.
Lilley, A., & Rogoff, K. (2020). Negative interest rate policy in the post-COVID-19 world. VOX, CEPR Policy Portal, April 17, 28.
Summers, L. H., & Rachel, L. (2019, March). On falling neutral real rates, fiscal policy and the risk of secular stagnation. In Brookings Papers on Economic Activity BPEA Conference Drafts, March (Vol. 7).
Tretina, K. (2021, April 9). NYSE: What Is The New York Stock Exchange? Forbes Advisor. https://www.forbes.com/advisor/investing/nyse-new-york-stock-exchange/
Wells, D. R. (2017). The Federal Reserve System: A History. McFarland.
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Question
Write a 5–7 page paper in which you:
Explore one financial market and the types of transactions supported by it in the United States and global economies. Determine how valuable these transactions are to the United States and the global economies.
Evaluate all the factors that affect interest rates to determine the one that appears to impact interest rates the most in today’s economic climate. Support your answer with evidence and examples.
Analyze the ease or difficulty of forecasting interest rate changes. Assess the value the forecast provides.
Examine why the Federal Reserve was created. Then, construct an argument as to whether or not the Federal Reserve’s major roles are essential to the U.S. economy.
Choose a recent monetary policy (adopted during the past 12 months). Analyze its current and future impact on the United States and global economies.
Imagine you are a financial manager. Develop a strategy for the use of bond markets by either an investor or a firm of your choice to meet a stated financial objective of your choice for that investor or firm.
Use at least four quality academic resources in this assignment. Note: Wikipedia and other Websites do not qualify as academic resources.