Financial Markets and Institutions - Essay Example

economy, impact of recent monetary policy on U.S. economy and the strategy for the use of bond markets. Foreign Exchange Market The foreign exchange market is an over-the-counter (OTC) market. The participants of foreign exchange markets are portfolio managers, importers and exporters, commercial banks, central banks, and foreign currency brokers. Types of Transaction and their benefits There are three types of foreign exchange transactions: spot transaction, forward transaction and swaps. A spot transaction includes deliver of the exchange by the seller of the foreign exchange to the buyer, on the spot, and the settlement of deal is within two business days.

A forward transaction involves an agreement between the seller and buyer of currency to purchase or sell a preset amount of currency for a rate which is determined in advance at a specified date in the future. A currency swap is defined as a conversion of one currency into another with an agreement to revert it back at some date in the future. Forward transactions are valuable to the U.S. and global economies in several ways. It can fully eradicate risk by locking in now the rate or price at which the transaction is going to be made in future.

Forward trading offer the economic benefits of risk control and price discovery as well as rich opportunity for speculation. It provides protection against price changes through hedging. Spot market is also considered as most developed market and central banks have judged it as the neutral market for interventions. Forward transactions also protect the investors and traders from exposure towards the fluctuations of the spot rate known as currency hedging. (Peng, 2008, p.194). Factors Affecting Interest Rates Interest rates are determined by the forces of demand and supply.

There are numerous factors that affect the interest rates and these are as follows: First is the monetary supply and demand. The interest rates for saving accounts of U.S. citizens can be affected by the demand and supply of the currency in circulation and more demand and less supply result in a higher rates being offered. Second is the inflation. Inflation rate impact interest rates because every lender desire returns from the loan in order to reflect the reduced purchasing power. They add the expected or existing inflation value to the interest rates to evade losses.

Third is the Central Bank policy. It helps to decide the interest rates for saving accounts. Fourth factor is the demand for credit. When the demand for credit is high, then the best savings account interest rates are seen. Interest rates tend to decrease with the decrease in the credit demand. Fifth factor is the economic state of the U.S. It enables to determine the interest rates for saving accounts. Interest rates tend to decrease with the recession and economic prosperity cause the interest rates to go up.

Sixth factor is the expectation of the economic growth. Interest rates tend to increase when economic growth is predicted. Seventh factor is the level of competition among financial institutions. When financial institutions compete for consumer business, then the saving accounts and best interest will be seen.