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Question:

Part A

  1. Get three recent financial or business newspaper cuttings on the interest rate changes. From the paper discuss;
    1. What are the main topics of the three newspaper articles?
    2. How will the news in these articles influence the local economy what are your opinions regarding these changes on interest rate?
    3. You can contribute your own opinions?
  1. Find three financial or business newspaper cuttings on the recent development on Inflation/deflation in any country and analyze them on.
    1. What are the main topics of the three newspaper articles?
    2. What are the major causes of Inflation/deflation?
    3. How does this effect on the local economy?
    4. You can contribute your own opinions?

Part B

Go to any central bank websites or foreign exchange websites find the National Currency of any country outside GCC currency or US Dollar and compare it with GCC currency or US Dollar.

  1. Collect information about the history of the country you have chosen exchange rate determination from various sources.
  2. Use the graph tool on the webpage and creating your own data (excel) to provide a graph showing the exchange rate for a period of one year. Your graph should include several sudden and sharp increases of the exchange rate (almost vertical) and several periods that the exchange rate was largely constant. Identify these periods in your graph and discuss the major concern on these changes.

Part C

Get recent academic Journal (10 years or less) on bonds or stocks from the paper;

  1. Produce a critically reflexive summary of the paper based on what you understand on this article attach copy of the article
  2. Short summary of how it does contribute to your understanding on the topic Bonds or stocks
 

Answer:

Part A

Article 1: “Fed Raises Interest Rates for Sixth Time Since Financial Crisis”

a)The main topic of the above article is the increase in interest rate by 25 bps in US and also expected two more rate hikes in 2018 so that the Fed rate can lie between 1.5% -1.75% p.a.

b)The given interest rate hike was quite expected and would potentially prove to be beneficial for the economy as inflation is increasing which can if not contained lead to potential overheating of the economy. This rate hike comes at the back of a prolonged period of low interest rates prevalent in the US since the global financial crisis in 2008. It is expected that the rate hike could spur off some demand but the Fed has been careful not to increase the interest rate steeply so as to adverse impact the growth in any material way. The macroeconomic indicators such as inflation, GDP, unemployment data, wage growth clearly reflect revival in the economy. Owing to the hike in rate, it is expected that there would be appreciation of the USD against the other foreign currencies since there would be fund flow from foreign countries into US owing to the higher interest rate offered which would increase the demand for USD leading to currency appreciation.
 
 

Article 2: “Interest rate hike to adversely impact regional loan growth, cost of funds”

a)The given article highlights the increase in interest rate by number of countries in the Gulf region after the US Fed decided to increase the rate by 25 basis points.

b)It is expected that the increase in interest rates would lead to increased cost of loans and hence can potentially adversely impact growth. However, the precise impact of this on the local economy would depend on the prices of oil going forward. In the recent times, there has been an improvement in the oil prices and hence the government revenues are increasing reducing the need for government finances. However, going forward if the oil revenues do not sustain, then there could be pressure on government finances and hence this rate hike could adversely impact growth. I think the above assessment is very fair considering that the government revenues are primarily dependent on revenues derived from oil and therefore oil prices are key to determining the precise impact of the interest rate on economic growth. However, in the current scenario it would be prudent to conclude that the adverse impact would be negligible.

Article 3: “India lowers interest rate after economic slowdown”

a)The selected article highlights the lowering of the interest rate by the Reserve Bank of India on account of concerns regarding slowing economic growth rate.

b)The central bank has lowered the interest rate in the expectation that this would enable increase of economic growth which has slowed down. Additionally, the inflation fell to a five year low in the Q2 2017 which prompted the RBI to decrease the interest rate by 25 bps. It was expected at the time that the decreasing interest rate would reduce the cost of funds and thereby increase the loan offtake and spur the demand. This would increase the economic growth in the future and push inflation higher and hence near to the target range. Further, on account of lowering interest rate, there is expected to be depreciation of the rupee (local currency of India) owing to some capital reallocating to other emerging markets with better interest rates.
 
 

Part 2

Article 1: “U.S. Treasury yields rise to a new 4-year high as inflation concerns drag on”

a)The main topic of this newspaper article is the increasing inflation numbers in US and the impact of the same on US treasury yields.

b)The inflation in the US has reached a four year high driven by increasing consumer confidence and falling unemployment. Further, the economic growth in the economic is also picking up creating incremental demand which is responsible for the rising inflation seem in the US.

c)In wake of the rising inflation, it is expected that there would be more increases in the expected US Fed rates increase which typically enhances the yields on various bonds. This is because rising fed rates implies higher interest rates which have to be reflected in the bond market as well. This would tend to have adverse impact on the banking sector which might have to see plummeting values of their bond holdings if the trend continues.

d)I agree with the above analysis and also think that currency i.e. USD would be see appreciation going forward owing to higher inflation and potential rate hikes.

Article 2: “RBI Panel concerned about rising inflation, show minutes”

a)The main topic of the given article is how the rising inflation witnessed in 2017 had concern a concern for the RBI (Reserve Bank of India) during the recent monetary policy announcement.

b)In relation to the rising inflation, various reasons cited include higher food inflation coupled with high fuel prices on the back of the recent increase in crude price since majority of the needs are met through imports. Also, in order to improve the worsening agricultural distress situation, the government has decided to take a host of steps in the recent budget in which one of the decisions was to provide higher price for crops to farmers which is expected to further fuel food inflation,
c)Higher inflation figure could potentially prompt RBI to increase the interest rates going ahead if these fears do not. It is expected that the cost of borrowing would increase and it could adversely impact both consumer spending and private investment. This in turn can  lower economic growth.
d)Inflation fears are definitely worrisome for India considering the potential rate hike that could happen in order to contain inflation and that would have adverse impact on growth as outlined above.

Article 3: Bahrain's inflation continues to fall in February

a)As per the article, there has been a decrease in the inflation in Bahrain in February 2017 as it has touched a low of 0.4%.

b)The main reason for the low inflation observed in Bahrain is the drop in food prices which fell by a whopping 16% and more than nullified the rising cost on housing along with utilities. Hence, despite the increase in other costs, due to disproportionate fall in food prices, the inflation has fallen to very low levels.

c)The impact on the economy would be good considering that food inflation is lowering but the demand for other things remains robust as is apparent from the increasing inflation in housing and utilities. The lowering food inflation may be on account of global factors or rationalisation of supply constraints both of which are positive for the economy.

d)I tend to agree with the above assessment that lower inflation in the given circumstances augers well for Bahrain’s economy.

 

Part B

a)The country which has been selected for this task is India whose currency is Indian Rupee and is denoted by INR. The INR would be studied against the USD. India is a growing economy and is the second largest country in the world by population. The country has made rapid strides since its independence in 1947. The country suffered a major economic crisis in 1991 which led to major currency devaluation along with reforms in the form of liberalisation, privatisation and globalisation. Also, the country’s economy has a major share of services which comprises about 50% in the economy. The main exports of services are in the form of IT for which the country has made its global mark. The INR is a flexible currency and hence tends to fluctuate in real time.

b)The movement of INR against the USD for the last one year is captured in the graph shown below.

Currency depreciation – Period from November 2017 to January 2018

In this period, the INR depreciated quite sharply owing to higher US inflation data which signalled towards higher rate increases in the US. This would have led to flight of capital from India to US and thus the sharp depreciation.

Currency Appreciation – September 1, 2017 to October 15, 2017

There was appreciation in the INR owing to improving inflows in the capital markets of India owing to various reforms implemented by the government. Also, the interest rates were lowered which led to higher growth in the economy.

Constant Period – April 15, 2017 to June 15, 2017

The currency witnessed sideways movement with no clear cut direction.

 

PART C

a)One of the key risks associated with the business is financial risk which is dependent on the capital structure of the business. If there is higher percentage of debt on the books of account, then it is assumed that there is a higher default risk considering that unlike equity debt needs to be paid back. This higher risk in accordance with the modern portfolio theory would imply demand of higher returns by the investors so that there could be sufficient compensation for investing in stocks with higher risk. In this light, the objective of the given article is to consider if the leverage is priced into the stock price in the firms listed on Karachi Stock Exchange.

In order to test the impact of leverage, the researcher has used the Fama French model which is an appropriate choice considering that it allows the flexibility to introduce various factors of risk and determine if their respective slope is significant or not based on the regression results. Also, the sample selected has been for a large period of 13 years which include both the period of boom preceding the global financial crisis, the crisis period itself and the recovery period. This implies that the results obtained would be unbiased. Also, there are objective criteria for the selection of sample firms in relation to the sectors and minimum duration of listing. The exclusion of financials from the sample is positive considering the volatility observed during the financial crisis of 2008.

Based on the CAPM result, it has been highlighted that no significant risk premium has been observed for the high leverage and this result is in line with that obtained from other market as well. However, the financial risk associated with the company may be priced in the stock price through other size, value related measured which are also linked to the financial risk. Also, the study does indicate how these factors are not essential indicators of financial risk and are only indirectly related.

b)The above journal article contributes to my understanding of stocks especially with regards to asset pricing models. There are various asset pricing models starting with CAPM and these models still have not been able to completely capture the risk associated with the stock. The portfolio theory essentially presents a very simplistic view whereby there is no unsystematic risk and only systematic risk remains which is captured through beta. But over the last five decades, it has been highlighted that multiple factor models are more appropriate for capturing risk (Brealey, Myers & Allen, 2012).

However, as is apparent with leverage risk, there does not seem to be any suitable risk premium associated with firms having higher leverage which essentially goes against the basic idea that risk and returns are related. Therefore, it is apparent that asset pricing models especially in the context of stocks are still in evolution phase as these are being tested against new empirical data available from emerging economies (Damodaran, 2010).

 

References

Amaro, S. (2018) U.S. Treasury yields rise to a new 4 – year high as inflation concerns drag on. Retrieved from https://www.usatoday.com/story/money/markets/2018/02/12/us-treasury-yields-rise-inflation-concerns-drag/328410002/

Arabian Business, (2017).  Bahrain’s inflation continues to fall in February. Retrieved from https://www.arabianbusiness.com/bahrain-s-inflation-continues-fall-in-february-667889.html

Augustine, B.D. (2017) Interest rate hike to adversely impact regional loan growth, cost of funds. Retrieved from https://gulfnews.com/business/sectors/banking/interest-rate-hike-to-adversely-impact-regional-loan-growth-cost-of-funds-1.2142303

Brealey, R. A., Myers, S. C., & Allen, F. (2012) Principles of corporate finance (2nd ed.) New York: McGraw-Hill Inc.

Damodaran, A. (2010). Applied corporate finance: A user’s manual (3rd ed.) New York: Wiley, John & Sons.

Kazmin, A. (2017) India lowers interest rate after economic slowdown, Retrieved from https://www.ft.com/content/878d2066-776d-11e7-90c0-90a9d1bc9691 

Mirza, N., Rahat, B. & Reddy, K. (2016) financial leverage and stock returns: evidence from an emerging economy. Economic Research- Ekonomska Istrazivanja. 31 (4), 2-25. https://www.tandfonline.com/doi/full/10.1080/1331677X.2016.1160792?scroll=top&needAccess=true

Tankersley, J. (2018) . Fed Raises Interest Rates for Sixth Time Since Financial Crisis. Retrieved from https://www.nytimes.com/2018/03/21/business/fed-interest-rate.html

The Hindu,(2018). RBI Panel comcerned about rising inflation, show minutes. Retrieved from https://www.thehindu.com/business/Economy/rbi-panel-concerned-about-rising-inflation-show-minutes/article22817309.ece
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