Term Paper on "Financial Markets and Institutions"

Term Paper 5 pages (1581 words) Sources: 5

[EXCERPT] . . . .

Financial Markets, Institutions, And Transactions

Financial markets can be described as marketplaces in which sellers and buyers are engaged in buying and selling commodities, currencies, equities, and derivatives. These transactions are carried out based on efficient market prices, which indicate overall projections about the future by every investor. Trade in financial markets and institutions are also based on basic trading regulations, market forces, and costs. Since these markets can be found in nearly every part of the globe, they are classified as domestic or international financial markets. Notably, some of the current financial markets are accessible to private investors whereas others are specifically for major global banks and professionals in finance. Moreover, there are several types of financial markets with varying types of transactions supported by the different economies across the globe.

Capital Markets:

One of the most common types of financial markets is capital markets, which is characterized with different types of transactions across economies. These markets primarily involve the trade of securities by individuals and financial institutions. While organizations usually sell securities in order to raise funds, capital markets are made up of primary and secondary markets. Primary markets are a marketplace where newly issued stocks and bonds are exchanged while secondary market involves the trade of existing bonds and stocks.

Financial transactions in capital markets occur when trading securities i.e. stocks and bonds and are supervised by financial regulatory bodies ("Capital Market Transactions," 2013). Therefore, the financial transactions in a typical capital market involves the buying and selling of bonds and stocks. As previously mentioned, these markets serve as the ideal marketplace for organizations and governments to generate funds. Financial transactions in capital markets are usually carried out by brokers registered with the exchange to conduct trade activities on behalf of their customers. This implies that a person cannot invest in stocks or bonds independently since he/she must go through brokers in orders to carry out such transactions.

The main value of financial transactions in capital markets throughout the United States and global economies is that they help governments, banks, and corporations to generate long-term funds. However, trading of bonds and stocks is not usually an easy process for both novices and experienced investors because of the difficulty associated with forecasting capital market trends. Governments, banks, and corporations raise money through transactions in the capital markets in order to fund their operations and get involved in their own long-term investments.

Factors that Affect Interest Rates:

Interest rates are described as the basic macroeconomic indicator of an economy and are usually presented as aggregate figure. The use of these rates as macroeconomic indicators is fueled by their information regarding the current banking and financial information in an economy. Since interest rates are the costs of borrowing money, they provide a clear indication of the supply and demand of money within a specified period of time.

There are several factors to consider during the evaluation of the present and future movement of interest rates. One of these major factors is the current state of the economy since changes in the economic and financial system have significant impacts on interest rates. Generally, when the economy experiences growth, there is an increase in demand for funds that result in increase in interest rates because consumers not only have jobs and savings but they also borrow for large items ("Factors Influencing Interest Rates," n.d.). The other factors that affect interest rates include inflationary forces, the strength of the dollar because it's the main currency in global trade, international forces, changes in the U.S. economy, deferred consumption, political gains, and supply and demand.

The main factor that appears to affect interest rates the most in today's economic climate is monetary policy. Monetary policy involves interventions by the national authorities in order to control the growth of the economy as well as the inflows and outflows of money. Through monetary policy, the government may choose to stimulate the growth of the economy either through enhancing or reducing interest rates. For example, in the United States, the Federal Reserve regulates the printing and value of money in the economy. The regulatory body establishes the baseline or main interest rate in the country's economy. Therefore, the Fed can either infuse or take away money from the U.S. economic and financial system.

Forecasting Interest Rate Changes:

Forecasting the future level of interest rates is one of the most frequent but least accurate financial predictions because every prediction of increase in interest rates requires a forecast of decrease in these rates. This process can be carried out through qualitative and quantitative approaches by considering macroeconomic variables. The process of forecasting interest rate changes can be regarded as a difficult procedure because it's least accurate and requires stability in order to improve accuracy. The inaccuracy associated with this process is attributed to the fact that these rates are reflections of human behavior that is usually very complex.

The globalization of financial markets and economies has enhanced the complexity and difficulty of forecasting interest rates ("Forecasting Interest Rates," 2013). While experts are notorious for inaccurate forecasts, governments miss forecasts of these rates despite having control of monetary and financial policy. However, forecasting interest rates is one of the most important and valuable financial processes. These forecasts are valuable because they play a crucial role in determining the current value of streams of future payments or wealth. Furthermore, the forecasts enable firms, governments, and individuals to have reduced exposure to interest rate risks.

Why Federal Reserve was Created:

The Federal Reserve, which is commonly known as the Fed, was created by the U.S. Congress to act as the nation's central bank. This body was established to provide America with a more secure, more stable, and more flexible financial and monetary system ("What is the Purpose of the Federal Reserve System?" 2013). The United States central bank was created in December 1913 following the enactment of the Federal Reserve Act by President Woodrow Wilson. Since its inception, the Federal Reserve carries out various functions and responsibilities that are classified in four major categories i.e. conducting America's fiscal policy by affecting financial and credit conditions and supervising and regulating financial institutions. The other functions are providing some financial services to the government and financial institutions and maintaining the stability of the country's financial system and markets.

Therefore, the major roles of the Federal Reserve are essential to the stability and growth of the U.S. economy. Generally, this body controls all the financial activities and transactions that are carried out by various stakeholders in the economy. The essence of the Fed's essential roles to America's economy is evident in the fact that it acts as the guardian of the economy by implementing policies that keep the country functioning smoothly.

Centennial Monetary Commission Act:

One of the recent monetary policies to be adopted in the United States monetary system is the 2013 Centennial Monetary Commission Act. This policy was established in order to create a Centennial Monetary Commission to examine the nation's current monetary policy. This policy would have significant short-term and long-term impact on America and international economies. The short-term impact of the act is to determine the effect of the Federal Reserve on America's economic performance based on financial stability, output, prices, and employment. This will in turn help determine the astonishing interventions that the Fed has made into the U.S. economies, which has in turn affected global economies. From a long-term perspective, the act will contribute to significant and effective reforms by suggesting a course for the U.S. future monetary policy based on legislative and operational approaches ("Centennial Monetary Commission," 2013).

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