Report Example on Economic Theory

(2)Using economic theory, analyze changes in the cash reserve ratio across the time period

The economic theory proposes that reserve requirements can be used as monetary policy tools. With regards the theory, when the reserve requirement is set at a higher value, then the amount that will be available for banks to lend out is going to decrease. This will result in low creation of money consequently increasing the purchasing power of the money in the economy. Under this proposition, there is multiplication of the impact, and this is due to the fact that cash which is received as loan proceeds is deposited again, at the same time, a fraction of the deposit can be given out as loans again. When the reserve requirement is high, the supply of funds which can be loaned out decrease, thus increasing the rates of interest leading to slow economic growth. The economic theory therefore affects banks, the amount of cash they can hold and the cash reserve ratio.

The amount of money which is preserved in the deposits is known as the cash reserve. Cash reserve is expressed as a percentage. They are mostly need when there is need for the withdrawal of deposits by the depositors so that more credit can be generated. When more credit is generated, there will be more loans and the profits will increase significantly.

Analyzing the cash reserve graph above, it can be seen that the cash reserve ratio was below the 4% mark in 2017. This could be attributed to the high confidence level of Barclays Bank at that time. In addition to that, the economy of United Kingdom was growing, the economy was performing well. The reserves were growing at a steady pace and between 2006 and 2007; they reduced to a level of 21.7%. In 2008, a financial crisis hit the whole world. This resulted in a drop in the value of the bank assets. There were also fears of greater default rates among the banks which had withstood the financial crisis. Barclays Bank was affected as well, and there was an increase in the cash reserves by 315% in the year 2008. The following year, the cash reserves increased by 161% and this was because very few loans had been created. As such, more money had been left in the reserve. Barclays bank valued their liquidity compared to their profitability during that period. Between 2007 and 2009, the cash reserve ratio shot up from 2.6% to 25.8%. This could be attributed to the increase in reserves, and the fact that the change in the value of the deposits was negative. This negative change was as a result of the increasing rates of employment, consequently reducing the disposable income available which makes it impossible for households to store their savings. The cash ratio reserve kept increasing. In the year 2011, it hit 29.7%, the recession was ending slowly but most the levels of confidence were still low. In 2012, the cash reserve ratio started reducing. The UK economy was growing more stable, the confidence levels were increasing while the amounts of disposable income were rising as well. The cash reserve rations reduced by a margin of 62.4% between 2011 and 2014 and it has remained fairly the same till 2017.

(3)Using economic theory, analyze changes in the capital ratio across the time period

The capital ratio is used in assessing and evaluating the financial assets of a bank through two main parameters; capital and assets. When the capital adequacy ratio of a bank is high, that bank is said to be safe and it can therefore be able to meet its financial obligations without failing. The capital reserve ratio, on the other hand, is the amount of money which banks have to maintain in their reserves. It is not possible to lend out this money to customers. The capital ratios were fluctuating, increasing at times and decreasing at times. Some of the factors which could be attributed to the increase in the capital ratio include; the increase in the capital during that respective year and a decline or drop in the risk-adjusted assets. Some of the factors which could be attributed to the decrease in the capital ratio include a reduction in the prices of stock of the bank and a reduction in the deferred tax assets of Barclays Bank, UK.

Barclays Bank tried to boost their capital through generating more cash while retaining their earnings. This implies that the bank was embarking to build up its capital reserves. In addition to that, Barclays Bank also tried to raise their capital ratios through the sale of equities.

(1)Why are debt securities an attractive means of borrowing for firms?

Debt financing is crucial for companies. There are several reasons why firms need cash. The capital may be required to cater for expenses and pay bills, fund the ongoing projects of the firm, deal with any financial crises that the firm may be going through and to expand its activities. There are two main ways through which firms raise the cash that they spend. These two are debt finance and equity finance.

Debt finance involves the process of raising cash through borrowing from a lender. The borrower makes a pledge to the lender to repay the cash after a certain period of time. The most effective way of debt financing is dependent on two main factors; who the borrower is and the creditworthiness of the company/firm and the amount of cash to be involved in the transaction process. There are two main categories of debt financing. These two are issuing debt securities and through taking loans. There are also other methods such as securitization and vendor finance. A debt security can be defined as a financial tool; it is a signed document which acknowledges the existence of a debt. The person who issues the debt securities pledges to pay back the investor the borrowed amount of money after certain duration of time (after the maturity of the debt security). However, there is some interest added while paying the original amount that was borrowed. It is easy to trade debt securities between investors, just as is the case with equities. There are several forms through which debt securities occurs. These include; commercial papers (they are almost similar to bonds and they do not take more than a single year to mature), medium term notes (these debt securities are issued under medium term note programmes. They take up to thirty years before they can mature) and bonds (these are junk bonds and Eurobonds; they take a single year to mature. In other instances, according to the deal signed, they can take more than a year)

Some of the reasons why debt securities are an attractive means of borrowing for firms include;

Terms and conditions: The terms and conditions involved in the issuance of debt securities are not that strict or stringent. Normal loans have very stricter and stringent laws and regulations which discourage firms from borrowing.

Interest rates: Normal loans usually contain a floating rate of interest. However, when it comes to debt securities, their rates of interest are flexible. This is because of the fact that there are several options for debt securities; they can have zero coupons, have rates which are fixed or have floating rates.

Security: When seeking normal loans, security must be provided. This can be in form of assets, equipment or land. On the other hand, debt securities do not have to contain securities.

Information disclosure: When it comes to the issuance of the debt securities, information with regards to the one issuing the securities is limited to the info which is in the public spheres. When a firm seeks a loan in a bank, the bank usually carries out a detailed and in depth analysis of the company seeking the loan. The firm does not need to disclose all these information the debt security issuer.

(2)Why are they attractive to certain investors?

Reasons why debt securities are attractive to some investors include;

Wide investor base: Compared to traditional loans, debt securities have a wider and bigger group of potential investors. This therefore implies that the issuer may incur can pay a more competitive price for borrowing compared to a normal loan.

Trading: It is possible to transfer debt securities as they are usually listed on the stock exchange market. They are exchanged in international capital markets as well. It is therefore possible for the investor to loan out the money to the issuer and he will not have to wait until the maturity period is over to receive payment. This is due to the fact that debt securities are transferrable; the investor can therefore sell them to recoup his investment.

(3)Choose a week in January 2017. Identify the changes in yield of a UK government benchmark bond across the week

Between Jan 20th and Jan 23rd, there was a sharp decline in the yield bonds. Then from 23rd Jan to Jan 26th, the yield bond rose significantly. From 26th Jan to 27th Jan, the yield bond dropped.

(4)Using relevant theory, illustrate and explain changes in the yields observed.

The changes in the yields within the week could be attributed to the changes in the rates of interest and the changes in credit quality. Other factors that may have contributed to the changes include; fluctuating economic conditions, for example, treasury bills rise during when the business records high profits and they fall when profits reduce. The profit made daily cannot be constant, it keeps fluctuating and as such, this played a role in influencing the yield changes.

If there are fears that the government may default in its debt, then the most probable action will be demanding higher bond yields. This will act as compensation for the risks involved. The private sector also influences the yield bonds increase or decrease. When the levels of saving among the private sector is high, the consequence is that the demand for bonds is going to increase since they will seem as a great way through which one may make good use of savings. Consequently, this will result in lower yields. People have a tendency of saving more in periods where the rate of the growth for the economy is low and the market conditions keep fluctuating.

Expectations on the economic growth also impact the bond yield. Bonds are investment tools, just as is the case with shares or private capital. When the rate of economic growth is high, this will increase the investments on shares and private capital thus rendering bonds less attractive. The effect of this is that it makes the yield to go up. Inflation is another factor that could be attributed to the yield changes. When there are fears that the market may be hit with inflation, the real value of bonds is going to reduce significantly. When the inflation is low, the demand for bonds is going to be high and this will result in low bond yields. However, when the rate of inflation is high, the demand for bonds is going to reduce and this will result in greater bond yields.

Changes in the rates of interest also have an impact on the bond yield prices. This is because discount rates are affected by the rate of inflation in the country. Due to inflation, the rates on interest rise, meaning that the discount rate is going to increase as well. Consequently, the prices of bonds is going to reduce,

(1)Trace changes in the exchange rate of the currency against one another over the course of the day

(2)Use economic and financial theory to analyze the observed change in the exchange rate

One of the financial theories applied in the exchange rate scenario is the foreign exchange market theory. This foreign exchange market can be defined as the market on which different currencies belonging to different countries are traded together. The rate at which the exchange process takes place is re...