Role of Government in Financial Market Intervention
Discuss about the Unconventional Monetary Policy System.
Government intervenes in the financial market through framing policies and imposing regulations. Economy is stimulated by employing simulative monetary policy by reducing unemployment rate and increasing economic growth. Money market securities are assets that are invested for short-term period with a maturity of one year or less than a year. Corporate bonds are securities that are issued by corporations for long-term on which owners are promised to be paid coupon payments on semiannual basis. IPO or Initial public offerings are the issuing of shares for the first time by company when they go public.
Government intervenes in the financial market through framing policies and imposing regulations. Regulation and controlling of financial market is heavily influenced by government intervention that helps financial institutions in providing efficient financial services by minimizing riskiness. Aim of government to regulate financial market is to promote higher level of efficiency and protect public interest. Interest of investors and borrowers in financial market is protected by development of policies by government that helps in lowering transaction costs. Uniformity in financial market is established by implementation of developed policies by government (Kiley and Roberts 2017).
Economy is stimulated by employing simulative monetary policy by reducing unemployment rate and increasing economic growth. It helps in stimulating without concerning about inflation as such policy would cause an increase in inflation. Business investment in an organization can increase by increase in supply of money due to employment of this policy (Neely 2015 pp.101-111). This leads to increase in supply compared to demand and thereby lowering interest and ultimately cost and debt and equity. It might happen that banks limit the credit even though the government increases level of bank funds. Banks in such situation might not be willing to extend credit and this would lead to lower interest and lower consumer spending (Becker and Ivashina2015 pp.1863-1902). Under such situation, inflation will be adversely affected and growth of money supply will be disrupted.
Money market securities are assets that are invested for short-term period with a maturity of one year or less than a year. It is regarded as good place to invest funds for shorter time period. Some of securities that come in the category of money market securities are commercial paper, treasury bills, banker’s acceptance and certificate of deposits and are issued by trustworthy and large organizations including government of United States. These assets carry relative low risks as compared to other assets and it make up the mainstream of money market securities that are traded in capital market. Since the maturity for these assets is short, they are generally regarded to be of high grade. Investors are provided with low return as low risks are associated with such assets. An investor investing in money market securities is provided with liquidity and they have the potential of higher yield compared to conventional cash such as through credit union and bank account (Cox et al. 2016).
Stimulating Economy through Monetary Policy
Bonds- Bonds are securities that are generally invested for long-term and are issued by corporations and government agencies. Periodic payment of interest is obligated to be paid by issuer of bond. Buying of bonds will be considered by investors for which the question of repayment is raised if the risks associated with it will be compensated by generation of sufficient funds. The flow of funds is facilitated by bond market and proceeds generated by issuing of bonds are used for supporting government programs deficit.
Institutional participation in bond market- The macro structure of bond market is explained by involving institutions as development of such markets requires strong institutional support. The momentum of corporate bond market is sustained by steady and gradual development of framework of institutions. Tilting of scales of corporate bonds can be done by development of institutions. Financial institutions dominates bond market and active participation of institutions helps in effective functioning of bond market (Belongia and Ireland 2015).
Bond yields-Bond yields are the amount of return generated to investors when they realize bond or when bonds are matured. Yield to maturity helps in measuring cost of financing of issuer.
Treasury and federal agency bonds- A treasury bond is a fixed interest, marketable and debt security bond issues by government of United States. This type of bonds are issued for financing activities of government spending. Federal agency bonds are bonds that are issued by federal budget agency or they are sponsored by agency of US government. Maturity period of such bonds ranges from one year to forty years (Cukierman 2013 pp.373-384).
Municipal bonds- Municipal bonds are issued by local and state government to finance the difference between revenues generated and spending of government. Revenue bonds and general obligation bonds are two types of bonds that are issued by state or local government.
Corporate bonds are securities that are issued by corporations for long-term on which owners are promised to be paid coupon payments on semiannual basis. Maturity period of corporate bonds is generally between 10 to 30 years and the minimum denomination is $ 1000. Cost of financing corporate bond gets reduced as the interests that are paid to investors by corporation is tax deductible (Harford and Uysal 2014 pp.147-163). This is the reason why corporations finance their operations using corporate bonds.
Issuing of bonds by corporations or firm enable them to restructure their asset and revise their assets by way of features and several benefits. Corporate bonds helps in lowering the overall weighted cost of capital. This is so because issuing of bonds increases the liabilities of issuer and this increases cost of debt. Increase in cost of debt provides organization is offset by benefits of tax deductibility. Therefore, firms are saving by falling cost of capital. Furthermore, issuing of corporate bonds can be used to finance purchase of assets if required by organization. Fall in overall cost of capital will lead changing minimizing of equities and debts for financing of firms (Shim et al. 2013 pp.26-33). Organizations are thereby able to revise their structure of capital.
Benefits of Investing in Money Market Securities
Corporate bond issuance by firms has indirect impact on weighted cost of capital. This is so because, financing the business by issuing cost will increase the total amount of liabilities as compared to issuing of equities. Moreover, benefits received in the form of tax deductibility on interest helps in lowering cost of capital. An organization willing to expand can use the money generated through issuing of bonds in purchasing assets (Kacperczyk and Schnabl 2013 pp.1073-1122).
Initial public offerings- IPO or Initial public offerings are the issuing of shares for the first time by company when they go public. IPO also happens when an unlisted companies sells existing securities or issue new securities. Initial public offerings are generally issued by startup companies because they seek funding for their growth by raising of capital. IPO is considered attractive for organization as it helps in boosting their business growth.
Process of going public- An organization intending to go public or issue IPO needs to undergo a specified process and steps. In the first step, investment bank is required to be selected. Secondly, regulatory filings and due diligence is to be performed by issuing company. In third step, offer price is determined by underwriter and issuing companies provided by underwriter any. Stabilization is provided by underwriter in fourth stage. Transition to market competition is the last and final stage of process of IPO (Valdez and Molyneux 2015).
Underwriter efforts to ensure price stability- After issuing of stocks, underwriter creates market for stocks that have been issued along with after market stabilization. In the event of any imbalances, after market stabilization are carried out by underwriter by buying shares at below offering price or at offering price (Belongia et al., 2015 255-269). For instance, if stock demand is unexpectedly low, the extra shares in market place is bought back by underwriter and thereby assisting in price stabilization.
Initial returns of IPOs- Initial return is the difference or variation between offer price and after math price after the day of trading. Initial returns generated by IPO fluctuate dramatically over time. Organizations whose value is difficult to estimate experiences higher volatility of returns.
Abuses in the IPO market-Abuses in IPO market is of three types that comprise unlawful disclosure of insider information, insider information and manipulation of market. Unlawful disclosure arises when inside information is disclosed to any outside person expect in the normal course of their employment. Manipulation of market occurs outside trading venue that involves providing false and misleading signals and contracting financial instrument at abnormal price (Duygan et al. 2013 pp.715-737).
From the above discussion, it can be concluded that government plays a significant role in regulating financial market institutions. Monetary policy helps in stimulating economy An investor investing in money market securities is provided with liquidity and they have the potential of higher yield compared to conventional cash such as through credit union and bank account. Looking at IPO process, underwriter plays a significant role in price stability and there are many abuses in such market.
Becker, B. and Ivashina, V., 2015. Reaching for yield in the bond market. The Journal of Finance, 70(5), pp.1863-1902.
Belongia, M.T. and Ireland, P.N., 2015. Interest rates and money in the measurement of monetary policy. Journal of Business & Economic Statistics, 33(2), pp.255-269.
Cox, J.D., Hillman, R.W. and Langevoort, D.C., 2016. Securities regulation: cases and materials. Wolters Kluwer Law & Business.
Cukierman, A., 2013. Monetary policy and institutions before, during, and after the global financial crisis. Journal of Financial Stability, 9(3), pp.373-384.
Duygan?Bump, B., Parkinson, P., Rosengren, E., Suarez, G.A. and Willen, P., 2013. How Effective Were the Federal Reserve Emergency Liquidity Facilities? Evidence from the Asset?Backed Commercial Paper Money Market Mutual Fund Liquidity Facility. The Journal of Finance, 68(2), pp.715-737.
Harford, J. and Uysal, V.B., 2014. Bond market access and investment. Journal of Financial Economics, 112(2), pp.147-163.
Kacperczyk, M. and Schnabl, P., 2013. How safe are money market funds?. The Quarterly Journal of Economics, 128(3), pp.1073-1122.
Kidwell, D.S., Blackwell, D.W., Sias, R.W. and Whidbee, D.A., 2016. Financial institutions, markets, and money. John Wiley & Sons.
Kiley, M.T. and Roberts, J.M., 2017. Monetary policy in a low interest rate world. Brookings Papers on Economic Activity.
Neely, C.J., 2015. Unconventional monetary policy had large international effects. Journal of Banking & Finance, 52, pp.101-111.
Shim, S., Serido, J. and Tang, C., 2013. After the global financial crash: individual factors differentiating young adult consumers’ trust in banks and financial institutions. Journal of Retailing and Consumer Services, 20(1), pp.26-33.
Valdez, S. and Molyneux, P., 2015. An introduction to global financial markets. Palgrave Macmillan.
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