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Financial Markets and Risk - Essay Example

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Introduction “Monetary policy is a tool used by the central bank to manage money supply in the economy in order to achieve a desirable growth.” (The Economic Times, 2011) The major role of any monetary authority is to decide on a rate of interest from time to time depending on the economic conditions prevailing in the country in order to promote growth and maintain stability…
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Financial Markets and Risk
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Financial Markets and Risk

The long term savings and investment products offered by banks and NBFI’s are mostly life assurance, pensions and other investment products such as fixed deposits with a long term maturity. Fixed deposits are time deposits which give a higher interest rate than the normal demand deposits. Pension products are aimed at meeting the retirement needs of investors wherein a lump sum amount is given to the investor which is accrued over the years. Investing in bonds (government and corporate) is another option where there is more safety even though the returns may be comparatively less. Some banks and many NBFI’s provide platform to invest in mutual funds also. II. Implications for individual savers and investors of a significant increase in the general interest rates. The most visible effect due to the increase in interest rates is on the loans borrowed and deposits made by individuals. An increase in interest rate means increase in the repo rates of banks. This will result in an increase in the mortgage loans’ interest as well as other loans and debts like credit card debt. The increase in interest rate on loans will force the individuals who already borrowed the loans to pay more on the interest and this will lead to fewer savings. Those who had plans to borrow loan will postpone the same in order to be relieved of the extra burden of higher interest repayment. Another aspect is with the timing preference of making deposit. Since the interest rate is high, the return on investment from banks in the form of deposits will also be high which will prompt the individuals to make more investments out of their savings. Exchange rate changes can also be an effect of interest rate change. When the interest rate increases, there will be more inflow of foreign money in the form of FIIs. This will lead to an increase in the value of the domestic currency. The implications are that, the individuals who invested in foreign currency will see their value of investment come down in terms of domestic currency due to the decrease in value of the foreign currency, other factors remaining the same. Also this will make imported goods relatively cheaper to the domestic buyers which in turn force the domestic producers to reduce their products’ price which means more savings for the individual. Rise in interest rates will also affect stock and securities like bonds. When interest rate rises, the price of existing bond falls. This is because investors can get higher rates on newly issued bonds. A rising interest rate may affect the stock market also because 1) investors will turn to buy bonds as they give better yield, 2) investors need to pay more to borrow money and spend them, which will lead to a slump in the growth of many companies which produce consumer goods. III. Risks to commercial banks of a significant rise in general interest rates. All banks face interest rate risks. Changes in interest rate can reduce a bank’s earnings and lower its net worth. Interest rate risk is defined as the volatility in earnings or the value of a financial institution owing to unexpected changes in interest rates. “The chief source of interest rate risk is the mismatched re-pricing of a financial intermediary’s assets and liabilities.” ... Read More
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