Assignment 1: Financial Markets and Institutions

Answer 1

Money Market

Money market facilitates the flow of short-term funds from those with surplus funds to those with insufficient funds. Market players for money market are government, financial institutions, corporations and individuals. It supports the trading of short-term securities i.e. with maturity of one year or less. These include treasury bills, certificate of deposits, repurchase agreements etc.

Importance of money market transactions

Money market plays a vital role in the economy of a country. It helps financial institutions and corporations to maintain their liquidity position and government to implement monetary policy in the country. Government trades in these securities for two purposes i.e. to implement monetary policy, and to minimize deficits. Corporations fulfill their liquidity requirement for any new or existing projects by issuing money market securities. Financial institutions participate to maintain liquidity so that loans can be provided to households and corporations. (Madura, 2012, p.123)

Answer 2

Factors affecting interest rate:

Factors that affect the interest rate the most are:

Prospects of production i.e. opportunity to earn a higher return on investment.

Attitude towards saving or consumption.

Loan riskiness

Expected future inflation rate (Besley & Brigham, 2011, p. 128)

The most critical factor that affects the interest rate the most is risk. Currently Federal Reserve is keeping the interest rate low (www.federalreserve.gov), in order to retrieve the previous state of the economy. The financial crisis of 2007-2008 affected the US economy in the worst manner. People lost their confidence; hence tendency to take risk has decreased sufficiently hence people have become risk avert. This has affected their preference of future return over current, and even though more opportunities of getting a higher return are present people are not investing.

Answer 3

Forecasting interest rate changes

Interest rate risk management is of equal importance for a manager of an organization ...