MA514 Business Finance

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MA514 Business Finance

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MA514 Business Finance

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Course Code: MA514
University: Melbourne Institute Of Technology

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Country: Australia

Question:

Task:
Select a country of your choice. The teacher has the discretion to allocate a country to each student or can allow students to choose a country.
For your chosen country, research the central bank website, websites of major financial institutions, Bloomberg and Reuters websites, and products offered by the financial institutions.
Construct a report.
Economic conditions of  
Consider the information presented by the central bank of your chosen country, such as information about the following economic indicators – GDP, inflation, employment data, and housing loan approvals.  Decide what stage of the business cycle you think the country is in and explain 3 reasons why.
Include in your response a graph or picture of the current yield curve which you construct yourself in MS Excel and import into Word.
Overview of the Financial System
Provide an overview of the financial system in your country and include the following information:
Currency (or currencies) used as a medium of exchange, how it is typically valued, the current value, and credit rating of the currency · Amount of government debt expressed in US$ and as a percentage of the country’s GDP, whether this has been increasing or decreasing and why · Name of the stock exchange (s), what products are traded on the exchange and how many stocks are listed on this exchange – hours of trading · Name of the derivatives exchange (s) (if there is one) and what products are traded on this exchange – hours of trading · List the regulators in the financial system of your country and provide a brief outline of what types of things each regulator is responsible for · Name examples of various types of financial institutions, and construct a diagram of how the flow of funds between surplus and deficit units is applied in your country between these institutions · Size of capital markets in US$  · Size of money markets in US$ · Size of the over the counter derivatives market in US$
Product examples
For each of the following scenarios, recommend a product which best suits the clients’ needs and explain the features of the product.

A small corner store has decided to renovate and needs to borrow $30,000 to proceed with the renovations.  Provide a calculation of how the business owner can repay the loan.  Include in your response, assumptions of length of the loan and the interest rate.
A bank needs to borrow $5,000,000 for a period of 48 hours to cover a short-term funding requirement.  Assume an interest rate and just calculate the amount of interest that the bank would need to pay on a simple interest basis.
The government needs to fund a budget deficit.  No calculations required, please specify the product.
A 22 year-old, graduate engineer has $8,000 to invest and wants to keep adding $300 per month to the investment on a regular basis for the long term but is not happy to take much investment risk.  Include an assumed rate of return, select a specified duration of investment, and predict how much the engineer could have saved by that specified time in the future.
A portfolio manager is concerned that equities are not going to perform as well as they have in the past but does not want to sell the portfolio due to cost reasons.  No calculations required but please specify the three types of products, which could be used, and how they are traded.

Market risk
Distinguish between market risk and specific risk and provide an example of each from your country.

Answer:

Economic conditions of US:
This part intends to analyse economic condition of the US through considering gross domestic product (GDP), inflation, employment between 2005 and 2018 along with housing loan approvals (Harrison et al. 2018). Through analysing these indicators, the report can state the stage of business cycle in which the country is operating with the help of appropriate explanations.
GDP:

Figure 1: Annual GDP growth of US
Source (Data.worldbank.org. 2018)
According to above figure, GDP growth of US became low during 2008 to 2010 due to global financial crisis (GFC). As the GFC was started from this country, it affected US’s economic condition adversely. After this situation, GDP growth started to increase drastically though later it fluctuated by small proportion. However, since 2016, GDP growth of US has started to increase continuously.
Inflation:

Figure 2: Inflation rate of US
Source: (Data.worldbank.org. 2018)
The above figure has represented inflation trend of US. According to figure 2, inflation of US fluctuated drastically between 2007 and 2012. After 2015, this macroeconomic indicator has started to increase at a slower rate. The average inflation during this period remains at 1.54 percent, which in turn helps economic condition of this country to improve further.
Employment:

Figure 3: Employment in US
Source: (Data.worldbank.org. 2018)
Figure 3 has considered employment to population ratio of US considering employees aged above 15 and others. According to this diagram, employment in terms of total population has started to increase after 2011. This implies that economic condition of this country has become strong after experiencing GFC.
Housing loan approvals:

Figure 4: New home sales in US
Source: (Data.worldbank.org. 2018)
The estimated demand for US mortgage to purchase a home has increased strongly over the last one year. Regulators have conducted various reforms after GFC to stabilise mortgage market of this country. Previously, housing market suffered a lot due to short-term loan along with loosely regulated companies and insufficient incentives. Private mortgages also experienced various obstacles. Figure 4 represents that sale of new homes increases over the year since 2010. Thus, housing market has experienced a slow and lower growth rate. This implies that approval of housing loans is not easy for US economy, as the number of defaulter has increased over the time.
Business cycle:
The business cycle of an economy consists with four phases, which are, expansion, peak, recession and trough. When a country experiences expansion, GDP and employment of it increases significantly. Moreover, inflation of this economy also increases simultaneously. According to above discussion, based on four macroeconomic indicators, it can be stated that US economy is operating in the expansion phase of the business cycle. In 2007, most of the expansion declined, as the country’s economy experienced great depression (Abbritti and Weber 2018). However, after 2015, GDP growth of US and employment rate has started to increase over the time. On the contrary, inflation rate has increased at a lower rate. However, slow sales of houses and light vehicle have affected economic growth of this country. Hence, this mixed outcome based on above analysis clearly represents that US economy is in slow expansionary phase.
Overview of the Financial System:
Currency as Medium of exchange:
Currency acts as medium of exchange and refers as international instrument as well. This medium facilitates two parties for successfully transact goods and services with each other. In US, dollars are used as medium exchange.
The exchange rate of dollar compares its value with other countries’ currencies. This process helps the US to determine how much currency of a particular country can be exchanged for a dollar. These exchange rates between US dollar and other currency fluctuate every day (Baselga-Pascual, del Orden-Olasagasti and Trujillo-Ponce 2018). The demand for US dollar in world market helps to determine the value of it, as demand for other products help the market to determine their value. In this context, the concept exchange rate is considered. At present, 1 dollar of US dollar can purchase 1.42 Australian dollar and consequently the exchange rate between these two currencies are AUD/ USD = 1.42
Credit rating of US dollar:
Credit rating for the US, based on Standard & Poor’s, represents at AA+ with low risk. In addition to this, credit rating of Moody for this country last stood at Aaa with low risk.
Amount of government debt expressed in US$:
The government of a country generates government debt and this considers both internal debt and external debt. According to the Federal Budget of 2019 financial year, at the end of financial year of 2018, total debt of US federal government is accounted as $21.48 trillion (Bernardini and Peersman 2018).
In the first quarter of 2018, the federal government generates 105.23 percent of total public debt in terms of total US GDP. The trend of government debt as a percentage of total GDP has been increasing over the year since 2010. This implies that the government of this country increases its public debt continuously.

Figure 5: Total government debt as a percentage of GDP Australia
Source: (Data.worldbank.org. 2018)
The above figure also represents increasing trend of total government debt as a percentage of Australia’s GDP.
Name of the stock exchange:
  In USA, some large stock exchanges are the New York Stock Exchange (NYSE) and the Nasdaq (Tupper, Guldiken and Benischke 2018). Under these stock exchanges, future contract, delivery contract and option contract are traded.
Name of the Derivative exchange:
The Chicago Mercantile Exchange is one of the American derivative exchanges. Agricultural products like live cattle, feeder cattle, milk, cheese and butter and other products are traded in this exchange.
List the regulators in the financial system of USA:

Federal Reserve System: Main system of banking and controls overall banking system
Federal Deposit Insurance Corporation: Provide deposit insurance to various depositors of savings institutions and commercial banks
Financial Crime Enforcement Network: It combats against international and domestic money laundering.

Size of capital markets in US$:
The country has the largest market as well as deepest capital markets across the world. Based on the Federal Reserve, the capital markets give debt financing of almost 80 percent for business organisations of the US (Afonso, Baxa and Slavík 2018).
Size of money markets in US$:
The money markets in the USA are considered as a part of the financial market, which is used to generate short-term finance. As of 2017, the primary credit risk in the USA was 1.60.
Product examples:
Assuming the length of loan and interest rate:

Particular

Value

Loan amount

$ 30,000

interest rate

7%

Time

12

PMT

$2,595.80

 
The above calculation indicates that the overall monthly payment of $2,595.80 can be conducted for the loan amount of $30,000 with the interest rate of 7% and tenue of 12 months. The time period of the loan can be altered by the borrower, which would change the monthly payment structure.
Calculating the simple interest on the loan taken by the bank:

Particular

Value

Loan amount

     5,000,000

interest rate

1.48%

Total Interest

$74,000.00

 
Banks uses LIBOR rate for gathering short term loans, which is current valued at 1.48% and for the investment period of 48hours the bank has to pay the interest of $74,000 for acquiring the loan of $5,000,000 (DeFusco and Paciorek 2017).
Government funding a budget deficit:
The government mainly uses bond for acquiring the relevant fund from the market and minimize the budget deficit, which occurs while conducting operations.
Predicting how the engineer could have saved by the specified time in the future:

Particular

Value

PMT

300

PV

8000

Interest

0.26%

Time

240

FV

$84,714.43

 
The overall interest rate is mainly at the level of 3.10% annually, where the time period of investment is mainly calculated at 20 years. The consideration of the overall time period and interest rate would directly result in a future value of $84,714.43
Specifying the three products that can be used in the investment:
The risk of non-performing equities can be reduced with the help of adequate hedging measure, where the investor can use options, futures and delivery stock for reducing the risk from the portfolio (Diserens et al. 2018). The options contract can be used for reducing the risk from the portfolio by hedging the index contract. Investor with the help of broker can initiate the contract.
Market Risk
Distinguish between market risk and specific risk:
Market risk implies the possibility of losses that an investor can experience due to various factors that can influence overall performance of any financial market related to him or her. The investor cannot eliminate this type of risk, known as systematic risk, through diversification. Some chief sources of market risks are recessions, political turmoil, natural disaster and interest rate change and so on. On the other side, specific risk represents a risk, which can affect few assets. This form of risk is classified as “unsystematic risk”, where two factors can influence a company. These company-specific risks are financial risk and business risk (Cai et al. 2018). Companies can reduce their specific risks through diversifying portfolios. In this context, investors use exchange-traded funds for diversifying their portfolios. In a company, both external and internal factors generate business risk. Internal risk is associated with the operational efficiency of any business. Thus, it can be stated that market risk and specific risk represent two distinct forms of risk, which can influence assets, where market risk influences a large number of assets and specific risk affects a particular company.
The US experienced global financial crisis (GFC) in 2008 that created market risk in this country (Leiss and Nax 2018). During this period, all financial institutions experienced losses due to systematic risk, which did not affect only one bank but influenced the entire financial industry.
In US, various companies fail to protect new products with the help of patents. This can be referred as internal risk, which in turn reduces competitive advantage of these companies. The Food and Drug Administration (FDA) disallows some specific drugs that a company sells. Moreover, US companies also experience financial risk, associated with the capital structure over the country (Oh and Patton 2018). On the contrary, companies experience inconsistent earnings along with cash flow due to weak capital structure and this further can protect companies from trading.
References:
Abbritti, M. and Weber, S., 2018. Reassessing the role of labor market institutions for the business cycle. International Journal of Central Banking, 14(1), pp.1-34.
Afonso, A., Baxa, J. and Slavík, M., 2018. Fiscal developments and financial stress: a threshold VAR analysis. Empirical Economics, 54(2), pp.395-423.
Baselga-Pascual, L., del Orden-Olasagasti, O. and Trujillo-Ponce, A., 2018. Toward a More Resilient Financial System: Should Banks Be Diversified?. Sustainability, 10(6), p.1903.
Bernardini, M. and Peersman, G., 2018. Private debt overhang and the government spending multiplier: Evidence for the United States. Journal of Applied Econometrics, 33(4), pp.485-508.
Cai, J., Eidam, F., Saunders, A. and Steffen, S., 2018. Syndication, interconnectedness, and systemic risk. Journal of Financial Stability, 34, pp.105-120.
Data.worldbank.org. 2018. United States | Data. [online] Available at: https://data.worldbank.org/country/united-states [Accessed 8 Oct. 2018].
DeFusco, A.A. and Paciorek, A., 2017. The interest rate elasticity of mortgage demand: Evidence from bunching at the conforming loan limit. American Economic Journal: Economic Policy, 9(1), pp.210-40.
Diserens, C., Fragnière, E., Holenstein, C. and Rufino, S., 2018. Paradoxes of Portfolio Performance Calculation for Wealth Management: Avoiding Reporting Pitfalls. Journal of Financial Risk Management, 7(03), p.205.
Harrison, D., Coughlin, C., Hogan, D., Edwards, D.A. and Smith, B.C., 2018. Regional economic impact assessment: Evaluating remedial alternatives for the Portland Harbor Superfund Site, Portland, Oregon, USA. Integrated environmental assessment and management, 14(1), pp.32-42.
Leiss, M. and Nax, H.H., 2018. Option-implied objective measures of market risk. Journal of Banking & Finance, 88, pp.241-249.
Oh, D.H. and Patton, A.J., 2018. Time-varying systemic risk: Evidence from a dynamic copula model of cds spreads. Journal of Business & Economic Statistics, 36(2), pp.181-195.
Tupper, C.H., Guldiken, O. and Benischke, M., 2018. Capital market liability of foreignness of IPO firms. Journal of World Business, 53(4), pp.555-567.

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