Financial Markets And Institutions Part 2 Essays Examples

Financial markets play a critical role in the operation of economies of various countries owing to the nature of these markets to provide liquidity to various forms of securities. The markets allow both buyers and potential buyers of these securities to interact freely. Through the existing regulations in these markets, efficiency in operations is achieved In addition, these markets helps in the determination of the various costs of these securities thereby helping in effectively pricing these securities (Burke & Litwin, 1992). In the United States, these markets have played key role in improving the operations of the economy owing to the ability of the markets to allow effective flow of information to different stakeholders involved concerning vital aspects in relation to the securities. Among the different forms of securities traded in these markets include treasury bonds, stocks, treasury bills, municipal bonds, futures, among other forms of derivatives. In line with these revelations, the paper will majorly focus on critical examining a number of facets in relation to treasury bonds, swaps, and general bonds. The effects of these derivatives in creation of wealth in various countries will be analyzed with close reference to the United States (Burke & Litwin, 1992).
A bond is a form of long term investments where investors lend money to organizations for a specific period. Owing to the diverse nature of bonds, institutions will adopt the usage of varies bonds depending on the desired facets of that specific bond. There are certain terms that are related to the usage of bonds. They include coupon rate, the principal amount and the maturity date (Essential dental public health, 2013). The coupon rate defines the interest that will be paid for the bond at the end of the specified period. Maturity rate, however, is the defined period that the interest and the principal amount should be paid. In terms of maturity, a bond can either be for a short term, medium term and long term. The maturity rate will highly influence the selection of the type of bond to be purchased by corporates. In addition, the element of the market price will also be highly integral in influencing the overall interests to be paid for these bonds. Market rates refer to the prices that are charged for bonds in the marketplace. In the event that bond prices exceed the market price then the bonds are at a premium. On the other hand, if the market prices exceed bond prices then it is said that the bond is sold at a discount. The aspect of the market price will therefore highly influence the purchase of bonds.

Swaps

Swap is a form of derivative that involves the exchange of various forms of securities. Swap is founded on the principle of resource endowment as parties involved in the swap process will accept terms that best fits. Parties will only accept to participate in swaps that allow them a comparative advantage. In swaps, parties will exchange all the terms in relation to the security exchanged (Essential dental public health, 2013). A swap involving bonds will see parties exchange terms such as the interests to be paid for the bonds and the maturity period. There are various forms of swaps that can be adopted depending on the targeted comparative advantage. Interest rate swaps will involve the exchange of fixed exchange rate system for a floating system. Secondly, currency swaps will involve exchanges involving the form of currency to be used in the repayment process. Parties will allow participating in this form of swaps if the currencies to be used favor the party. Finally, commodity swaps can also be assumed. This involves the exchange for a floating interest rate for a specified period for a specified commodity.

Treasury bonds

Treasury bills are government’s security instruments that are used in order to source funds for the government from various sectors in order to settle public debt. The use of treasury bills involves selling securities to the public at either a discount or par value. This is mainly in order to attract buyers. Notably, treasury bills are also issued for a short term period that is often either one year or less. Owing to the short-term nature of the securities, treasury bills are issued at no-interest. As a result of these aspects of treasury bills, they are considered to the less risky instruments hence they are widely adopted in most sectors.

Calculation of the maturity yield for treasury bills

Return to risk
There are a number of risks that are related to the use of various securities that sat times can compromise the targeted interest in the use of these interests. Among the common risks involve are relating to the fluctuation of prices in the market that will affect the profit attained. In connection to this, different forms of strategies can be adopted in order to prevent these adverse risks (McDonald & Keegan, 2002).

Bonds

Among the risk that is associated with the use of bonds include interest rate risk, inflation risk, and reinvestment risk among other various forms of risks. Interest rate risk relates to the fluctuations in the values of the interest that will compromise the price of the bond. When the interest rates increase, the overall prices of bonds will fall. On the other hand, a fall in interest rates will result in a rise in bond prices. These uncertainties will highly affect the valuation process of bonds. Inflation risk will, however, involve the fluctuation in the values of the currencies in the global market. Inflationary tendencies will tend to negatively affect the value of the bonds. This is because, as a result of inflation, high-interest rates will be induced resulting into the fall in the prices of bonds (Ireland, Hoskisson & Hitt, 2008). In attempts to prevent the effects of inflation on the valuation of bonds, the introduction of inflation- indexed securities have been made manifest in a number of sectors. Hedging strategies can also be used in strive to prevent cases of risks resulting from inflation. Hedging will allow for prior determination of the values to be remitted that will remain constant despite the changes in the inflation levels within the economy.
Swaps
The use of swaps is also associated with a number of risks that can jeopardize the whole plan. Among the common risks that are associated with swaps include currency risks. This relates to cases fluctuations in the value of various currencies. Currency risks often result into huge more so in events where the fluctuation is unfavorable. In order to curb these currency risks, among the possible adoption is the use denomination of both the securities exchanged in similar currencies (Ireland, Hoskisson & Hitt, 2008). This will prevent any cases of losses in the event of currency fluctuations.

Federal Reserve System

There are a numerous ways in which the operations of the Federal Reserve System affect the process of issuing and operation of these derivatives. This influence is manifested in the monetary policies that are implemented by the Federal Reserve Bank (Tushman & O'Reilly, 1997). The aspect of money supply that is solely controlled by the system greatly affects the valuation of the securities. In terms of bonds, increase in the money supply will result in inflationary tendencies hence increasing the interests rates charged. As a result of this, the value of the bonds will considerably be reduced making them less desirable (Ireland, Hoskisson & Hitt, 2008). However, in the event that the money supply is limited through monetary policies like reduction in the federal overall expenditure, there will improvements in the values of the bonds making them highly attractive. Treasury bills will also be affected by the aspects of money supply in the economy. However, since the prices of Treasury bills are fully controlled by the government, their prices will not be affected though high supply of money will make them less attractive. The value of the currency is critical in swap derivatives hence any slight changes in the value of the currencies will witness considerable effects in swap agreements. The Federal Reserve System controls the value of the currencies through a number of measures like devaluation and evaluation of the currency (Tushman & O'Reilly, 1997).
The use of treasury bills will best suit for investment activity for a period of 12 months or less. This is majorly due to the short-term maturity period. In addition, owing to the nature of the securities, not to attract interest, they should not be used for long-term investment plans. The use bonds, however, can involve a considerably longer period depending on the type of bonds adopted. Certain type of bonds like Treasury bonds can even be issued for long periods like 50 years (Ireland, Hoskisson & Hitt, 2008). This long maturity period in the maturity periods will be coupled with the availability of risk preventing techniques like hedging that will help in cubing any form of price fluctuations that could be realized. Municipal bonds that involve those issues by states and other corporates will in most cases be issued for long periods exceeding twelve years (United States, 2010). On the other hand, swaps will be used for a longer period however not exceeding five year periods. This is mainly because swaps are agreements that are prone to be affected by a number of factors among them changes in the existing regulations. In light of this, individuals and governments will get involve in exchange of obligations however for a considerably shorter periods.
In regard to the discussion, it, therefore, becomes pronounced that financial market plays a pivotal role in any economy hence the need for measures to be undertaken tailored at improving the market (United States, 2010). Among the measures that can be undertaken is increasing the general awareness of persons for the existing securities that will be key in making these securities more desirable. In addition, it is pronounced that numerous factors affect the operations of security markets. Cases of fluctuation of currencies are presented to detrimental in the sale of securities. This, therefore, presents the need for parties involved in the financial markets to critically identify these factors and then adopt desirable measures that will help in improving the desirability of the securities.

References

Burke, W. & Litwin, G. (1992). A Causal Model of Organisation Performance and Change. Journal of Management, 18 (3): 523–545
Essential dental public health. (2013). Oxford: Oxford University Press.
Ireland, R. D., Hoskisson, R. E., & Hitt, M. A. (2008). Understanding business strategy: Concepts and cases. Mason, OH: South-Western Cengage Learning.
McDonald, M., & Keegan, W. J. (2002). Marketing plans that work: Targeting growth and profitability. Boston: Butterworth-Heinemann.
Tushman, M. & O'Reilly, C. (1997). Winning through innovation: A practical guide to leading organizational change and renewal. Boston, MA: Harvard University Press.   
United States. (2010). The world factbook 2010. Washington, D.C: Potomac.