The financial markets are a significant component in the US economic sector. They have noteworthy contributions in the US economic development and the creation of wealth. As such, the Federal Reserve and other stakeholders endeavor to ensure that the financial markets run with minimal negative implications on the economy. Therefore, policies that protect the investors and the economy are oftentimes put in place. However, investment in the financial market, like other investments, involves risks. It is, therefore, paramount to consider possible risks before investing in any of the various securities. This paper attempts to investigate factors surrounding three securities, including treasury bills, corporate bonds, and credit of deposits.
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An analysis of the role financial markets play in creating economic wealth in the U.S
The US economy has significantly depended on financial markets for many years (Wong & Zhou, 2011; Guo, Zhou, Cheng, & Sornette, 2011). The US has a relatively more advanced/developed financial market system relative to other economies in the world. Studies have linked the development of the financial market to financial innovations, efficiency in resource allocation, and technological development (Wong & Zhou, 2011). As such, the developed status of the financial market in the US has a positive correlation with the creation of economic wealth.
Some of the economic sectors that are highly influenced by financial markets include growth in productivity, increased employment and augmented macroeconomic stability, higher returns on capital, and housing finance among other sectors.
Wealth creation is realized through the ability of financial markets to mobilizing savings, projects appraisals/evaluation, risk management, and the facilitation of economic transactions. Moreover, financial markets in the US alleviate financial frictions (Levinson, 2014).
A general overview three (3) securities
The treasury bills
Treasury bill “is a short-term U.S. Treasury security having a maturity of up to one year and a sold at a discount” (the United States. Federal Reserve, 2005, p. 126). The pricing of T-bill is done at a lower price than the face value of the bills. A bill worth $1000, for instance, can be sold at $970 with the differences between the pricing value and the face value ($30) being the expected return upon maturity or sale.
The First World War and the associated federal debts highly influenced the inception of T-bills (Meulendyke, 2013). During the war, the sale of T-bills was more suitable relative to other alternatives. The returns have been increasingly getting better apart from the great depression and the 2008 economic crisis (Hamid & Habib, 2015).
The issuance of corporate bonds is a strategy adopted by financial institutions to provide long-term financing (Jankowitsch, Nagler, & Subrahmanyam, 2014). They have long-term maturities (1year to 100 years). Corporate bonds are categorized according to companies/firms they represent. Some of the key industries that issue corporate bonds include public utility, transportation, industrial, financial, and real estate (Meulendyke, 2013).
Corporate bonds have less liquidity compared to T-bills and, therefore, their pricing depends on customer bids that exceed treasury biddings.
Annual issuance of corporate bonds in the 1980s registered drastic growth. However, the 1990 collapse of Drexel Burnham Lambert (then-largest underwriter) saw a drastic drop in corporate bond issuance. There was a recovery from 1993 onwards when more corporations started active underwriting (Meulendyke, 2013). The 2008 economic crisis severely hit bond performance, but the economic recovery has brought a resurgence in a good performance (Dick-Nielsen, Feldhütter, & Lando, 2012).
Certificate Deposits (CD) have served domestic financial institutions, including banks and credit unions, as a key source of funds since their inception in 1961 (Meulendyke, 2013). The issuance of CD works almost in a similar manner as the normal bank deposits done through bank accounts. Nevertheless, withdrawals of CDs are restricted by maturity. The pricing and returns in CD investment depend on various factors, including principal amounts, maturity durations, and issuers policies, among others.
Since the 1960s, CD investments have made drastic improvements with noticeable interruptions in 1969 and 2008 (Meulendyke, 2013). The insurance aspect in CD investments has attracted investors in the past, making it a viable source of corporate financing.
The current risk-return relationship in securities investments
Prudence in investment requires investors to consider risk factors before investing. Johnson, Jensen, and Garcia-Feijoo (2015) suggest that it is imperative for any wise investor to consider the Federal Reserve’s monetary policies and the restrictive, expansive, or indeterminate environments. In addition, it is worth noting each security in the US is prone to a specific type(s) of risks.
Treasury bill risks
Investing in T-bill is considered the safest security investment. However, the current economic factors in the US may expose T-bill investment to interest-related risks. As seen earlier, the Federal Reserve monetary policy highly affects return in securities investment. As such, changes in the interest rates affect long-term (one-year) T-bill returns. For instance, investing $99 for a one-year T-bill worth $100 and then making premature sales (first six months) with 3% rise in interest rate will translate to $98.5 (negative returns).
Certificate Deposits risks
Although CD investment is insurable, investors face some risks, which adversely affect their returns. A common risk facing CD investment today is the risk emanating from premature withdrawals. Withdrawing a CD before the maturity date implies that the investor will lose earned interests and face huge penalties.
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Corporate bonds risks
Corporate bond investments are highly prone to inflation-related risks and the consequent debt deflations. As such, returns on corporate bonds highly depend on the level of inflation and debt status. Unfavourable inflation levels drastically reduce returns in corporate bonds.
Strategies for maximizing return for the current risk-return relationship in securities investments
Observing the Federal Reserve monetary policies and investing accordingly is the best strategy that an investor can adopt to maximize returns (Johnson et al., 2015). In addition, an investor should consider specific risks that affect each of the securities.
An investor should purchase short-term bills since they are hardly affected by the Federal Reserve’s interest policies.
It is prudent for an investor to make proper projections on personal monetary needs before making investments on CDs. As such, they will avoid premature withdrawal and the associated losses and consequently increase returns.
It is paramount for an investor to monitor the inflation rates and their effects on corporate bonds returns. Investment in corporate bonds should be done depending on the projections of the inflation levels at the time of maturity.
The Federal Reserve, its monetary policy and their effects on securities investments today
The influence of the Federal Reserve and its policies on the financial markets is apparent. The Federal Reserve reacts to and influences the assets returns across a spectrum of financial markets. Johnson et al. (2015) suggested that the influences of the Federal Reserve policies are directed by the economic situation in the country as well as the global economic trends. As such, the economy influences what the authors termed as the primary and the Federal Reserve rates that work during the restrictive, expansive, or indeterminate environments.
The effects monetary policies on corporate bonds
Reports have been made on the possibility of the Federal Reserve increasing interest rates (Fidelity Investments, 2016). Monetary policies that increase the interest rates lead to falling bond prices and chances of inflation rising.
The effects of monetary policies on treasury bills
The treasury bills are a source of government short-term financing. As such, The Federal Reserve’s policies have a direct influence on the T-bills (Johnson et al., 2015).
The effects of monetary policies on certificate deposits
Raising interest by the Federal Reserve may have positive implications for CD investors and other savers. It is argued that low interests have adverse effects on investors in CDs (United States. Federal Reserve, 2012). Therefore increasing the rates will positively influence the CDs investment.
Securities investment in the future
T-bills are a worthy investment in the next 12 months and the next five years. The CBO projections indicate that interest rates are likely to rise steadily over the next years and settle at 3.2 % by 2019 (United States. Congressional Budget Office, 2016). The current good performance of the T-bills and the likely positive trends in the future imply that investing in T-bills will be worthy in the future, including the next 10 years (Johnson et al., 2015).
Investing in corporate bond in the next twelve months and years is a plausible idea. The Federal Reserve is likely to make gradual increases in interest rates in the near future implying that returns on corporate bonds will be positively influenced. However, Johnson et al. (2015) suggested that corporate bonds perform best when the interest rates are stable. The stability in the interest rates after 2019 will imply that investment corporate bonds will be better in the next five years and the next ten years than in the next 12 months.
Investing in the CDs in the next 12 months, 5 years and ten years will be a good idea. Increasing rates are more likely to favor CD investors.
It is evident that financial markets have crucial impacts the US economy. The Federal Reserve, therefore formulate policies that influence the sector. This paper has used three securities that operate in the US economy, including treasury bills, corporate bonds and certificate of deposits, to evaluate some of the factors that influence the financial markets.
A key influencer in the sector is the interest rates, which are determined by the Federal Reserve. Therefore, amidst other risks, investors should base their investments on Federal Reserve policies and interest rates.
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