The Australian Financial Market is operated by an electronic system referred to as the Australian Securities Exchange (ASX). It was developed in 2006 after the merger between the Australian Stock Exchange and the Sydney Futures Exchange.
The ASX runs under a self regulatory system that is operated by the Reserve Bank of Australia and the Australian Securities and Investments Commission. The Australian securities exchange market recorded a 46 percent increase in its net profits within the first year of its operation. Net profits recorded in 2007 were $313 million and operating revenues increased to $552.7 million.
The major markets in the Australian Financial Market are the bond, share, foreign exchange, interest and money market. The share or stock market is concerned with the trading of equities or shares, trust options and fixed interest securities. The Australian stock exchange market uses an automated system that allows traders to buy and sell stocks in the financial market (ASX, 2010).
Interest Rates
The negative effects of the 2009 financial crisis saw the increase of interest rates in the Australian market to 4.25 percent in April from a low of 3.75% in January and February. The interest rates further rose to 4.5 percent in May and June. The high interest rates led to an increase in cash rates and assets trading in the form of cash were deemed to be more profitable when compared to the relative yield achieved from the sale or purchase of shares; the high interest rates also led to poor company profits and revenues.
The high interest rates also led to increased mortgage payments that left an adverse negative effect on consumer incomes as well as their spending patterns (Case, 2010).
The negative effect of the high rates makes sectors of the Australian economy that are sensitive to interest rates such as the Australian Real Estate Investment Trust to be less attractive to investors. Investors are also affected by the high interest rates because of share prices which will retreat into the economy. The credit market will also be affected because the variable rates on using credit cards will go up as well as mortgage payments.
This will affect consumer spending on luxury or basic items that will in turn affect the revenues generated by businesses. A continued increase in interest rates will also affect the amount of money that will be used by businesses to repay their debts each year. This will lead to a majority of the businesses reducing the size of their loans to be used in expansion or growth activities and also limiting the number of loans they take in the future (Case, 2010).
Shareholders are also affected by the high interest rates in the event that a company is cutting down on its investment or expansion activities because of high debt expenses and a reduction in revenue. This might make shareholders to sell off their shares because of the projected future cash flows; Investors will also sell off their company shares because of the high rates and instead opt to trade in bonds and cash assets such as cash accounts and government bonds which are risk free investments that have higher returns.
Share market returns are deemed to be volatile and unpredictable in an economic environment characterised by high interest rates a situation that makes most investors to be more inclined to investing in cash assets (Cash, 2010).
The Australian economy has however recovered from the financial recession but the interest rates have continued to remain high an indication that the economy is performing stronger. The economy is also performing well because of the decreasing unemployment rate and the strength of the Australian Dollar.
The positive effects of the interest rates have been felt in insurance companies because of the high returns on investments in bonds. Importers are also benefiting from the high interest rates because of the strong Australian Dollar which ensures that there is a reduction on the import prices for commodities. Debt collection agencies have also benefited from the high prices because people defaulting credit cards, personal loan or mortgage payments will have to look for more money to service their monthly payments (Case, 2010).
Share Market
Recent information on the Australian share market shows that the yardstick index has gone down to 130.1 points which translates to 4265.3 or 2.9 percent. This is low when compared to the ordinaries index level of 4324.8 that was recorded in June and 4453.6 recorded in May.
March recorded the highest number in the index level with a recording of 4893 for this year. The all ordinaries index went down to 126.5 points to an index level of 42.86 (ASX, 2010). The Australian share market experiences sector rotation which refers to the positive cumulative returns experienced by stocks found in one sector for example the Australian mining industry at the expense of stocks in another sector such as the investment and banking industry (Li, 2009).
Sector rotation is attributed to a situation where investors remove their investments from one sector in the event share prices fall to another industry that is experiencing high share prices.
This leads to a situation where there are no net fund inflows and outflows. In such a situation, the stock market index moves very slightly either upwards or downwards given a situation where the stock market is experiencing rotational investment activities. Sector rotation regularly occurs in periods in the stock market that experience index range and bound trading.
Traders in the Australian stock market explain sector rotation as a short trading period that could be a few days or weeks in which an industry attracts large investments and buyer interest due to certain circumstances in the economic market such as mergers, or takeovers on particular shares within the industry. This results in a situation where buying interests of stock in the same industry increase because of their vulnerability (Li, 2009).
The increased buying interests are also driven by speculative funds derived from industries that have experienced profitability such as the Australian insurance sector which has continued to experience high profitability despite the fluctuations in the share market. In such a scenario, investments are being rotated between from the insurance industry to the retail, mining or hospitality industry. When the stock prices from either of these industries overshoot, investment money will be rotated into another industry (Li, 2009).
Sector rotation has a negative impact on small stocks because they have thin trading volumes. Sector rotation into or out of these stocks becomes more pronounced causing large price fluctuations that make it easier to detect. The rotation between large and small cap stocks also has a diverse effect on the stock market.
Large cap stocks are usually associated with companies that have experienced and continue to experience diversification while small cap stocks represent small businesses that are viewed as pure plays in the financial market. Large cap stocks are seen to be safer investment options while small cap stocks present a lot of risk to the investor despite the fact they yield higher returns on the investment (Li, 2009).
Money Market
The Australian money market rates have been extremely volatile in the past twelve months. The money market rates keep changing on a daily basis and the market has been unable to maintain a constant rate. The fluctuations in money rates have affected businesses such as banks, credit unions and building societies because these companies rely on the rates from the money market to determine the deposit rates that will be used in the retail industry.
The rates as from January to June 2010 were 4.20% in January, 4.16% in February, 4.33% in March, 4.55% in April, 4.80 in May and 4.89% in June (ASX, 2010). The management of liquid assets by Australian Corporations, the government and financial institutions is carried out by informally arranged markets for deposits, loans and short term debt securities. Money market securities have a maturity period of 90 or 180 days.
Banks and financial institutions are involved in the trading of bank bills and discount securities worth billions of dollars everyday in the Australian money market. The country’s money market is a typical liquid market that allows investors and traders to borrow and invest large amounts of money (RBA, 2009).
The money market however faced some negative effects in 2007 as a result of deteriorating credit quality which placed a greater value on retaining liquid assets. The increase of interest rates due to the economic recession also affected the money market in a positive and negative way.
The interest rates within these markets fluctuate according to the expectations of the cash rate or overnight indexed swap rates (OIS). The interest rates are however higher than the cash rates. The expectations are a small steady premium that is used to reflect the risk incurred by the borrower and the ease of selling or borrowing securities (RBA, 2009).
The global fluctuations between the money rates and the overnight indexed swap rates rose in 2007 after a French bank suspended the redemption of two of its funds as a result of experiencing difficulty in the valuation of assets. From that time, the money spread of the Australian dollar has exhibited high degrees of movement across different foreign currencies such as the US dollar and the Euro.
Bond Market
A bond market is also referred to as a debt, fixed income or credit market, The Australian bond market allows trades to buy and sell bond securities in the form of government bonds, corporate or asset backed bonds. Government bonds are the safest and most lucrative investment option for any investor willing to trade in the bond market.
The risk attached to investing in government bonds is very minimal when compared to that of stocks. The valuation of bonds in directly affected by the fluctuations in interest rates. When interest rates go up, the value of bonds goes down and when the interest rates go down, the buying price of the bond market goes up. However, the government’s ability to regulate the increase in interest rates protects the bond market from crashing (Edirisuriya, 2010)
Recent data on the Australian bond market shows that the debt market has faced a positive impact with the succession of bond offers that illustrate the recovery of the bond market. This has been as a result of investors looking for ways to finance their investments from the steady streams of debt by the local banks to borrowing from public debt markets. The resurgence of the bond market has also been initiated by the lower cost of converting investments borrowed in Australian dollars to home currencies.
The issuance of public debts in 2009 amounted to $101 billion. This figure excluded asset backed securities and $3.6 billion of the amount was from companies that were not banks and financial institutions (Curran, 2010). The Australian bond market rates were at their highest during the month of April with a rate of 5.79% and the market experienced low rates during February and March with a percentage of 5.48% and 5.33 respectively (ASX, 2010).
Foreign Exchange Market
The official currency used by the common wealth states of Australia is the Australian dollar (AUD) which was introduced in 1966. The AUD is ranked fifth globally as the most highly traded foreign exchange currency after the US dollar, the Euro, the Japanese Yen and the British Pound. The exchange rates are regulated by the Reserve Bank of Australia (Edirisuriya, 2010).
Recent market information has shown the foreign exchange market experiencing an upward and downward pattern of fluctuations in exchange rates when compared to the US dollar. The market experienced high interest rates during March and April with recorded rates of 0.91% and 0.93% respectively. The exchange rates were at a low in the following months of May and April with the exchange rate recorded being 0.84% for May and 0.85% in June (ASX, 2010).
The global financial recession had an impact on the AUD exchange rate because it created the adverse effect of low demands for export goods. Emerging market and industrial currencies also had an impact on the AUD because of their appreciation against the currency that was deemed to be low yielding. The AUD faced high volatility in the global market in 2006 that saw a depreciation in the currency. The result of the depreciation cost investors eight months of interest rate premiums (RBA, 2010).
References
Australian Securities Exchange (ASX) (2010) Stock market information and stock quotes. Web.
Case, T. (2010) Making money as rates rise. Web.
Curran, E. (2010) Australian corporate bond market stirs to life with offers. Dow Jones Newswires. Web.
Edirisuriya, P. & Viney, C. (2010) Money and capital markets. Australia: McGraw- Hill.
Li, E.A.L. (2009) Testing sector rotation in the Australian share market. Review of Social, Economic & Business Studies, Vol. 3, No.4, pp 99-115.
Reserve Bank of Australia (RBA) (2009) The Australian Money Market in a global crisis. Web.