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Financial Institutions or banks are very important and valuable for the sake of the economic growth of an economy (Gup, 1999). Therefore, the government of almost every country of the world likes to execute their growth through the existence of financial institutions. Apart from the financial institutions, there is yet another thing that needed to be there in an economy known as Financial Markets (Gup, 2003). This assignment is a Financial Market based assignment in which different provisions and elements of the financial markets would have been acknowledged and analyzed. There are three different parts of the assignment which further bifurcated into different answers.
Part-1: Forecasting of Interest Rate
Theoretically, an interest rate is a rate at which the borrower is liable to pay interest specifically for the utilization of money. The interest rate is basically a percentage of principal that paid a certain amount of money on the money borrowed from the financial institutions. It is important for this part to choose a country for the operations, except the United States and Canada. China is selected for this analysis (Tradingeconomics.com, 2015). China, the economic giant of Asia has the highest amount of foreign reserves and ability to become the largest economy of the world by surpassing the United States. The interest rate of China from 2005 to 2015 is as follows
China is one of those economies of the world that kept a high amount of interest rate which was not very appreciable, but still the organizations operated in the region are borrowing from the Central Bank rigorously. The average growth rate in the interest rate from the financial year 2005 to 2015 for China is 1.71%, therefore the interest rate of China in the next year will be 6.12%. It is better for the manufacturing company to use the floating rate for the borrowing instead of fixed interest rate, as floating rate usually depends upon the policies of the Government, and it may decrease from the aforementioned forecast (Tradingeconomics.com, 2015).
According to the World Economic Outlook (WEO) forecast related to the world’s economy, the growth was nearly 3.7% in the year 2013 and 2014, and it is expecting to increase to a level of 3.9% in the financial year 2015 (Imf.org, 2015)
The Gross Domestic Growth Rate of China was 1.8% in the financial year 2014 which increased to a level of 1.5%. From the trend line of the GDP growth of China, it is expecting that the GDP will grow by 1.6% in the year 2016 (Tradingeconomics.com, 2015).
High inflation rate would not be effective for an economy. China has maintained its inflation rate perfectly. The inflation rate of China in the economic year 2014 was 1.6%, and it is now on the level of 1.4%. It is expected that the inflation rate would increase to a level of 1.7% (Tradingeconomics.com, 2015).
The country has a prevalence of high amount of interest rate; therefore, it is more than essential for them to change their interest rate with the help of new monetary policy.
Fiscal policy usually associated with the policy of income and taxation. The fiscal policy of China is alright and perfect, and there is no need of any change in it
Capital flows of China had decreased heavily in the year 2014, that decreased some of the foreign exchange reserves of the country
The income level of the individuals will certainly have a direct impact over the demand and supply factor of loan-able funds within the country.
2. Economic Growth has nothing to deal with the interest rate of a country. However any changing in the inflation rate as well as in the monetary certainly has a direct impact over the demand and supply of the loan-able funds. If the central bank of China decrease their key policy rate in the upcoming monetary policy then it will certainly affect over the supply side of the loan-able, and it will also affect over the demand of the loans from both private and public sector.
3. After getting an immense consideration of the scenario of China, it is found that the economic position of China is very strong and powerful, and the country will try to decrease their interest rate from the current level of 6%. Getting loan on the fixed rate of 8% would not be effective on the basis of the current information; therefore floating rate interest rate should be selected.
4. The United States (US) is not a high profile trading partner of China, as the country is currently having some of the large Asian and European economies for their trading. Hence, there would be no impact of interest rate on China from the increasing or decreasing of the interest rate in the US region.
Managing in the Financial Markets
The company which has been selected for this particular part is Unilever. Unilever is one of the largest consumer goods company located physically in England, the United Kingdom (UK). Cleaning agents and personal care products are some of the major products in which the company deals with one of the oldest organizational structure.
Role of Financial Institution
No! the company is not a deficit unit
Unilever is one of those companies of the world which has a remarkable understanding of complying with the reporting standards. The company interacted positively and comprehensively with the financial markets and institutions in terms of getting loan from them and paying the loan as per the terms and on time.
The shares of Unilever are currently trading in two large stock exchanges of the world with the name of London Stock Exchange (LSE) and New York Stock Exchange (NYSE). The financial market, especially the banks and secondary shares market is assisting the company to strengthen their position in the market with positive mindset.
The purpose of this condition associated with analyzing the paying off behavior of the companies. Banks have to analyze the level of current ratio and debt to equity ratio of the companies before stipulate loan to them.
How the Flow of Funds Affect Interest Rate
Unilever is currently has its main office in the United Kingdom, and the prevailing interest rate within the region of the UK is quite stable and reasonable that will certainly strengthen the financial function of the company.
Unilever will be very interested in the future interest rate of the country because the scenario revealed that the economic power of the country is strengthening which will certainly has a direct impact over the interest rate function of the country.
The company is expecting that the interest rate will decrease in the future based on the findings of the stated scenario because the economic power of the company is getting stronger with the passage of time, which will allow the central bank to decrease the key policy rate of the country in order to increase the level of borrowings.
The cost of borrowing will decrease resultantly, if the anticipation regarding the loan policy of the company is correct
The expectation regarding the future interest rate will affect over the decision related to borrowed funds of the company because future expectation may related with the expansion of the network of the company. Apart from that this expectation will permit the company to have floating interest rate rather than fixed interest rate.
Influence of the Structure of Interest Rate
The yield curve will go with the prevailing interest rate of a country. In this scenario, wherein the interest rate is expecting decrease, the yield curve will have a downward sloping.
In terms of financing of debt through a 10-Year project, then it is valuable for the company to obtain the credit on the long term fixed rate, because no one in the company can predict the prevailing interest rate and the economic prosperity of the UK after the period of 10 years.
The information related to the Treasury and Government backed bonds prevailing in the country, along with the information of the yield giving by other similar companies. The key factors that will impact over the yield is the interest rate and inflation rate of the country
The company in this scenario has to get the latest information related to the current prevailing interest rate of the country that will help them to set their yield on the 10-year bond.
If the expected US Inflation Rate in the year 2015 will be 0.5%, then the rate of real return will be
= 1 + Nominal Rate / 1 + Inflation Rate – 1
= 1 + 0.21% / 1 + 0.5% - 1
= 1.21% / 1.5% - 1
Real Rate = 1.9%
As per the pure expectancy theory the expected yield on 1-year treasury securities in 1,2,3 and 4 years from now is as follows
Geometric Mean (0.21) + (0.64) + (0.96) + (1.25) = 0.63%
Two years treasury securities with securities of 2,3 and 4 years are as follows
Geometric Mean (0.21) + (0.64) + (0.96) = 0.50%
Three years treasury securities with 1 and 2 years are as follows
Geometric Mean (0.21) + (0.64) = 0.36%
Default Risk = 5%
Liquidity Premium = 0.8%
Tax Adjustment = 0.4%
Yield = (95%) * (0.8%) – (5%) * (0.8%)
Yield = 0.76% - 0.04%
Yield = 0.72%
Let suppose the mentioned below scenario
Price of the Bond = 100
Yield (1) = 7%
Yield (2) = 4%
Yield 1 = 100 * 7% = 7$
= 7$ * 30%
= 7 – 2.1
Cash in Hand = 4.9$
Yield 2 = 100 * 4% = 4$
= 4$ - 1.2$
Cash in Hand = 2.9$
Hence, corporate bonds will be more worthwhile for the investor
Gup, B. (1999). International banking crises. Westport, Conn.: Quorum.
Gup, B. (2003). The future of banking. Westport, Conn.: Quorum Books.
Imf.org,. (2015). IMF World Economic Outlook (WEO) Update: Is the Tide Rising?, January 2014. Retrieved 21 January 2015, from http://www.imf.org/external/pubs/ft/weo/2014/update/01/
shares, u. (2015). UNILEVER N V -NY SHARES (UN:New York): Financial Statements - Businessweek.Businessweek.com. Retrieved 21 January 2015, from http://investing.businessweek.com/research/stocks/financials/financials.asp?ticker=UN
Shubik, M. (1982). Game theory in the social sciences. Cambridge, Mass.: MIT Press.
Tradingeconomics.com,. (2015). China Capital Flows | 1998-2015 | Data | Chart | Calendar | Forecast | News. Retrieved 21 January 2015, from http://www.tradingeconomics.com/china/capital-flows
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