Dr. Mulugeta Dessie
Assignment 1: Financial Markets and Institutions, Part 1
November 2, 2014
Explore one (1) financial market and the types of transactions supported by it in the U.S. and global economies. Determine how valuable these transactions are to the overall U.S. and the global economies. In finance a bond is a debt security issued by corporations and government agencies to assist in their daily operations and functions. (Madura, J. (2012). When the corporation or agency issues a bond to the bond holder, they are actually issuing a debt and a promise to repay the original bond price plus interest in most cases.( Madura, J. (2012).The interest paid on this debt is considered the coupon payment and is usually paid semi-annually or annually. Depending on the type of bond, the coupon payment can be a fixed rate or it can change over the course of maturity. Bonds have maturities that range from one year to over fifty years. (Madura, J. (2012).
A bondholder might not want to hold the bond until the agreed upon date so they sell the bond in a secondary market in order to have access to their money again. A bond can be a municipal, a treasury, a junk, a corporate or an I-bond. There are also bonds considered convertible bonds that can be transferred into stock by the bondholder. “Bonds are an important part of the economy and contribute to two-thirds of the average daily trade in U.S. market. (Chernobai2011). Bonds are considered valuable because they are a means to wealth from an investor’s standpoint and they make business operations more accommodative for corporations. This is a direct route to gaining capital when it is needed.
2. 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. There are several factors in our economic environment that can affect interest rates. The first issue is economic growth. In our textbook it states that, “Changes in economic conditions cause a shift in the demand schedule for loanable funds which affects the equilibrium interest rate (Madura p57)”. If a business expects economic conditions to improve, they are also willing to borrow money for expansions and projects which causes an outward shift in the demand for loanable funds and upward pressure on interest rates. (Chernobai2011). There is a possibility that there could be a change seen in the supply for loanable funds as well but the change would probably be significantly smaller than the change in demand for loanable funds. A downturn in the economy will show the inverse of the relationships where the demand for loanable funds will cause an inward shift and downward pressure on interest rates. (Chernobai2011).
Inflation is a rise in goods over a period of time and is considered a factor because it affects the amount of spending by businesses and households. When prices are expected to increase households and business will make most of their necessary purchases before the price actually increases. Businesses and households are willing to borrow more funds to make those purchases before prices drastically increase. (Madura, J. (2012). This change in spending behavior causes an inward shift in the supply of loanable funds and an outward shift in the demand curve for loanable funds. The Federal Reserve is the institution that increases and decreases the money supply by selling and purchasing securities. They also influence the amount of deposits retained within commercial banks and other depository institutions. Using a stimulating monetary police, the Federal Reserve increases the money supply as well as the supply of loanable funds through the purchase of various securities. This type of monetary policy places downwards pressure on interest rates. The Fed may also enact “fiscal policies that produce more government expenditures than tax revenues which