Question 1
Financial markets are the channels dealing with funding of money in case of a deficit on the borrowers in the enterprise by direct financing such as selling them as securities. Central bank regulations and government intervention help in the control of monetary policy and interest rates in the economic markets. Having full control over monetary policies will ensure that inflation rates are reduced. As discussed in class, a reduction in monetary policy sinceJanuary 2016 had a great impact on the euro zone currency as investors in the foreign market increased their purchases due to the currency protection not to fall in terms of liquidity. Currently, inflation is seen to reduce as these policy implementations have been under continuous review through an organ called the Governing Council. It ensures that stability in the price of goods is measurable. Increase in interest rates will have a positive impact on the investors as cash equivalence will be strong and more products shall be exported increasing the country’s Gross Domestic Product in the long-term (European Central Bank 2016).
Question 2
The Euro crisis is a multiyear debt crisis in which country member states such as Greece, Italy and Cyprus were affected and unable to repay back their financial debts. Adverse selection and moral hazards are the belief that an organization such as the International Monetary Fund (IMF) will support the country solve their financial problems and give a guarantee to its creditors concerning their returns.Consequently, this might help in their encouragement to take more financial risks.
First, uncertainty about the valuation of assets that created defaults on mortgages and insufficient historical evidence that gave rise to doubt on the resulting effect on the value of financial securities. This, in turn, discouraged many investors as they were highly uncertain on the asset securities if they will rise or fall at maturity period. As the margin of this uncertainty in the market increases, lenders also became more aggressive in making selections on their choice of collateral which later led to credit borrowing contributing to declining in demand for these assets (Koralai 13).
As discussed, another problem was market beliefs on systematic risks that were overestimated to benefit the traders. This risk on securities was diversified and more risky on investment as the prices were too high than the stand-alone bonds. At maturity, credit rating agencies contributed to the underestimation of systematic risk leading to increased adverse selection. This was a burden n to financial institutions as they may not be able to hold back enough securities to use when an impromptu verse change occurs leading to liquidity shortages in the market (Koralai 14).
In addition, the third reason was a flight to funding and market liquidity that related to the idea that investors can obtain findings in the market and value with which an asset is traded. This implies that higher demand for liquid assets was directly elastic as it gave rise to lower demand for illiquid assets at the same time. Contrary to this, if the need for the illiquid asset is small, asset prices are determined for market liquidity. This lowered the average quality of these securities in the market creating an imbalanced equilibrium.
Question 3
As a financier, purchasing the stock of Ford will be of more risk, and I would opt to buy. The reason is that because he is a stock broker he understands more on a new product in the market and risks accompanied with it. Upon a new product introduction into the market, its sales go higher in the long-term as many traders would like to test its effects. In the end, I will know how much I used in its investment. Longer time periods in buying leads to higher rates of return as it will be expected to be stable in the long run. This can be achieved by developing a good strategy for reducing risks through spreading out the investments across my stocks to different companies to lessen the risk of losing all the money.
Using collective mutual funds for the stock that will make me have profits in the future such as saving of fuel consumption by 90 percent. Lastly, before buying the Ford stock, I will take into consideration investing in it through index funds due to uncertainties as this approach will help in allowing my broker to try and match the market structure at a relatively lower fee preventing loss of money during transactions with other buyers (Hamn15).
Question 4
In finance, the relationship between return on assets and return on equity is that they are both financial ratios used to determine a company’s sustainable growth rate. For a bank manager, this relation helps them to have flexibility for comparisons on differentials with other asset structures to each other and determining the net worth of the business. The banks also compare their internal product line in terms of financial and credit performance such as deposit services. Regulators should use this type of relationship as it helps them determine the value of the company assets and stock valuation in increasing their investments, in the long run, giving a positive return to the shareholders (Hannagan3).
Question 5
Transactions Bank of Canada makes for overnight operations include one, an increase in longer-term interest rates on households’ goods, consumption and firm’s investments weakening the dollar hence a low growth rate on net exports. Secondly, keeping actual output at equilibrium to avoid an increase in inflationary wage rates and price increase tremendously. Thirdly, increase in the targeted overnight interest rates tending to increase in the long-run as a result creating more financial capital as they will be trading at a higher dollar strengthening their currency (Ragan 24). Effects of increasing these interest rates are
The cost of borrowing increases through payment on credit and loans discouraging people from borrowing and saving. The buyers who already acquired loans will have less disposable income by spending more on interest payment lowering consumption on some products. Mortgage interest payment is increasing discouraging real estate investors to borrow loans as larger banks will taking the advantage of paying their debts and settle down their accounts.
Government debt interest payments will also increase. With this effect, citizens should expect higher taxable income on the goods consumed to avoid financial crisis and maintain the currency at a stronger position. Consumer business confidence will also be reduced as a rise in the rates discourages them for more investments hence making them withhold their previous stocks rather than investing in risky securities. Companies will also reduce their production until a fall in interest rates are experienced. Lastly, the rise has a positive effect on the value of bond as money will flow smoothly focusing more investors on saving in foreign banks because of the stronger pound increasing its purchasing power in the stock market. (Tejvan 2).
Conclusion
Long-term institutions such as the IMF should collaborate with the European government to restore the sustainability of the euro in the country through fiscal integration. Further, they need to adjust to the fiscal policies and management in the economy whenever a crisis occurs. If investors and lenders get more information about the financial market behaviors the more collateral, they will have and in the long-run maintain creditworthiness in the securities market is hence increasing their external financing through restrictive covenants reducing the amount of debt to be added at a future date.
Works Cited
European Central Bank. Account of the monetary policy meeting of the Governing Council of the European Central Bank. Web. 10 March 2016
(https://www.ecb.europa.eu/home/html/index.en.html)
KoralaiKirabaeva. Adverse Selection and Financial Crises.
(www.bankofcanada.ca/wp-content/uploads/2011/02/kirabaeva.pdf)
Ragan Christopher. Why Monetary Policy Matters: A Canadian Perspective. 2007. Web. 7 April. 2016. (http://people.mcgill.ca/files/christopher.ragan/WhyMPMatters_abridged.pdf)
Tejvan. Economics.Economics Help. (http://www.economicshelp.org/macroeconomics/monetary-policy/effect-raising-interest- rates/)
Tom Hannagan. Experian Insights. Experian. 2008. Web. 7 April. 2016. (http://www.experian.com/blogs/insights/2008/12/roe-vs-roa/)
Trent Hamn. 12 things you need to know before investing in stocks. 2015. Web. 7 April. 2016 (http://www.thesimpledollar.com/12-things-you-need-to-know-before-investing-in- stocks/)
