Financial markets influence economic development
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Financial markets influence economic development
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- 2. 2 TermPaper On “How Financial Markets Influence Economic Development”
- 3. 3 Group Name “Friends Forever” Submitted By: Rajkumar Victor Halder Department Of BBA Submitted To: K.M. Anwarul Islam Assistant Professor & Course Coordinator
- 4. 4 Department of Business Administration Letter of Transmittal 5 May, 2016 K.M. Anwarul Islam Assistant Professor & Course Coordinator Department of Business Administration Subject: Submission of Term Paper report. Dear Sir, We beg most respectfully to state that, we are the student. Here is our Term Paper reports that fulfills partial requirements for financial markets and institutions on BBA program. We completed our Term Paper on “How Financial Markets Influence Economic Development” In the report, I have tried to accommodate your valuable comments & suggestions. In this concern, if you need any further clarification, please contract via email/call.
- 5. 5 Thank you for your kind cooperation. Without your support, this report would not have been completed. So we are submitting our term paper report and requesting your acceptance. Regards, Supervisor’s Certificates This is to certify that the entitled “Financial Markets Influence Economic Development” submitted in partial completion of the requirement for the award of the degree in Bachelor of Business Administration from carried out by “Friends forever” group Department of Business Administration, Under my supervision and guidance that no part of this report has been submitted for the awarded of any other degree. He is permitted to submit the term paper ………………………………………………… Signature & Date
- 6. 6 K.M. Anwarul Islam Assistant Professor & Course Coordinator Department of Business Administration DECLARATION I hereby declare that, this Term paper has been done under the supervision of Mr. K.M. Anwarul Islam, Course Coordinator and Lecturer, Department of Business Administration,. I also declare that neither this Term Paper report nor anypart of this report has been submitted elsewhere for award of anydegree. Supervised By: K.M. Anwarul Islam Assistant Professor & Course Coordinator (BBA Programme) Department of Business Administration Submitted By: “Friends Forever”Group Member’s Signature Rajkumar Victor Halder ……..…………………………………….. Signature & Date Department of Business Administration (BBA Program)
- 7. 7 ACKNOWLEDGEMENT At first I would like to express our -felt thanks to almighty ALLAH for his kind blessing for complete of this report successfully. We would like to heartiest thanks our honorable course teacher & supervisor, K.M. Anwarul Islam, Course Coordinator and Lecturer Department of Business Administration, for his guidance, help and encouragementthroughoutthe progress ofthe Term Paper report. Iam very grateful for his kind advice and instructions. Their guidelines, suggestions & inspiration helped us a lot.
- 8. 8 EXECUTIVE SUMMARY Financial markets are important in enabling economic growth in any economy. They are closely connected to all markets and almost all individuals in an economy (Winkler, 1998).This amplifies the importance of financial markets which lies with the fact that they are linked to all spending decisions in an economy. A flow of funds analysis is certainly the best way of highlighting the close interlink age between real activity and financial markets. The funds circulating in a financial market on the other hand are either from locals or from foreign directinvestment. On the case oflocal investments, the gain of an economic agentfor example a household or firm results from the loss in another financial agent, i.e. for an agent to incur a financial surplus then an agent in the economy has to incur a financial deficit; the sum of all financial balances in an economy, works out to zero (Winkler, 1998).Contrary foreign direct investment does not affect two agents in the economy the investment is from external sources, thus it propagates a gaining situation for the local economy. The sum of all financial balances includes the investment from external sources thus does no add up to zero (Winkler, 1998).Financial markets perform the primary function of intertemporal and interpersonal resource transfer, and are monetary markets. Although foreign direct investment can be in different forms, it still embodies the fact that it adds financial value total local economy. FDIinduces a number ofpositive effects to the local economy in the form of technological transfers, managerial skills, introduction of new process and productivity gains.FDI generally relies on capital from abroad, and thus the spillovers for the host country significantly rely on the domestic financial markets development. Consequently, spillovers will not be restricted to the improvements in a local business by taking advantage of the new knowledge, purchases of new machines and equipment and the hiring of skilled labor and management. Local investmentis capable ofavailing the required financial resources but might be constrained in providing
- 9. 9 the new technological advancements and potential entrepreneurial needs. Foreign direct investment has the potential to create backward linkages butin the absence ofdeveloped financial markets, this is rigorously hampered. FDI through linkages that multinationals create allows existing firms in a host economy to achieve economies of scale and even help in creation of new firms (Hirschman, 1958).
- 11. 11 INTRODUCTION The financial sector is a vital part of an economy because of the role it plays in intermediating savings of the private and public sector to productive activities including investment. Bangladesh financial system is dominated by the banking sector, which fundamentally depends on short- and medium-term deposits for financing their lending portfolios. This limits availability of funds that would be required for long-term investments like infrastructure and housing. Bangladesh has a capital market, with its known difficulties, and there is no vibrant secondary marketfor bonds, which limits the availability of resources for infrastructure financing. This paper starts with a general overview of the current structure of the financial system in Bangladesh in terms of the 4 key markets—money market comprising banks, microfinance institutions and nonbank financial institutions, stock market, bond market and insurance market--and their sizes, relationships between the various markets and the associated regulatory bodies assigned to govern the different market segments. It then analyzes recent performance of these markets by looking at their important constituents and identifies the key challenges these markets are facing which could undermine their intermediation role in allocating resources to the key sectors and activities to supportachievementofthe Seventh Plan objectives. In particular, intermediation of private financial resources through the banking system, and mobilization ofresources for private investment through the capital and bond markets will be important for achieving the investment targets under the Plan. The paper then recommends for each of the markets the corrective reforms which will strengthen their operations and enhance/accelerate marketdevelopment. As we are passing through the final year of the Sixth Five Year Plan (SFYP) period, the discussions will be cast in relevant cases against the objectives/targets established under the SFYP. The remainder of the paper covers the following issues. Section II discusses the overall structure of the financial system, which is comprised of four main markets, their developments over time and relative size, and regulatory
- 12. 12 management. Monet market related issues are analyzed in Section III. This section provides an overview ofpastand recentdevelopments in the banking sector of Bangladesh covering important issues such as structural reforms of 1980s and 1990s, indicators of banking sector performance, progress with Basel II and preparations for Basel III, monetary policy management of Bangladesh Bank, Interest rate related issues, developments in foreign exchange market, and impact of liberalization offoreign currency denominated borrowing on the banking system. This section also highlights the setbacks to the banking system due to banking scams and default loans, developments and outlook for microfinance institutions in Bangladesh, gains made in terms of financial inclusion, and developments and issues related to nonbank financial institutions. Section III also discusses the challenges and concerns relating 2 to the banking sector and a comprehensive agenda for money market reform and operational improvements. Section IV discusses capital or stock marketrelated issues. Itprovides discussions on historical background of the capital market including the turbulent episode of 2009-14; and current state of the capital market in terms of key market indicators. This section also provide a discussions on the progress made with structural reforms in the post correction period and makes a number of recommendations based on capital market studies made in recent months. Bond market related issues are covered in Section V. Following discussions on the current status of the bond market in Bangladesh, this section also focuses on constraints to developmentofthe bond market and policy recommendations. This section also covers related issues like current status of pension funds in Bangladesh and prospects related to issuance of municipal bonds in Bangladesh. Specific policy recommendations relating to developmentofthe overall bond market, pension funds, and municipal bonds are also noted in this section. Section VI covers issues related to the insurance market—its current state and the agenda for reform. Some concluding observations are presented in the final section (Section VII) of the study. Financial markets and institutions A financial market is a market in which financial assets (securities) can be purchased or sold Financial markets facilitate transfers of funds from person or business without investment opportunities (i.e., “Lender- Savers”, or “Surplus Unit”) to those who have them (i.e., “Borrower- Spenders”, or “Deficit Unit”) Funds transferred directly from Ultimate Savers to Ultimate Borrowers is called Direct Financing. A financial "intermediary" transforms financial claims with one set of
- 13. 13 characteristics into financial claims with other characteristics e.g. deposits are used to make loans. Example: A bank giving loans to the borrower is indirect financing Financial markets and their important Financial markets play a critical role in the accumulation of capital and the production of goods and services. The price ofcreditand returns on investment provide signals to producers and consumers— financial market participants. Those signals help direct funds (from savers, mainly households and businesses) to the consumers, businesses, governments, and investors that would like to borrow money by connecting those who value the funds most highly (i.e., are willing to pay a higher price, or interest rate), to willing lenders. In a similar way, the existence of robust financial markets and institutions also facilitates the international flow of funds between countries. In addition, efficientfinancial markets and institutions tend to lower search and transactions costs in the economy. By providing a large array of financial products, with varying risk and pricing structures as well as maturity, a well-developed financial system offers products to participants that provide borrowers and lenders with a close match for their needs. Individuals, businesses, and governments in need of funds can easily discover which financial institutions or which financial markets may provide funding and what the cost will be for the borrower. This allows investors to compare the cost of financing to their expected return on investment, thus making the investment choice that best suits their needs. In this way, financial markets direct the allocation of credit throughout the economy—and facilitate the production of goods and services. Financial markets and their impact on economy Individual’s wealth Activities in Financial Markets have a direct impact on individual’s wealth, the behavior of businesses and the efficiency ofour economy.Hence 3 markets deserve particular attention as any movement in these markets have a direct impact on individuals, businesses, markets and the economy Bond / DebtMarkets Where interest rates are determined Stock Markets A major impact on people’s wealth and on firm’s investmentdecisions Foreign Exchange MarketFluctuations in the exchange markets have a direct bearing on the economy Market
- 14. 14 Monetary Policy Monetary policies affects interest rates, inflation and business cycles, all of which have an important impact on financial markets and institutions, it’s important how monetary policy is conducted by Central Banks and other financial institutions channel funds from people who might not put them to productive use to people who can do so and thus playing a central role in improving the efficiency of the economy Monetary Policy Interest Rates, Inflation, Business Cycles Financial Markets & Institutions. The interaction between financial markets, economic growth and monetary policy is by no means a new issue for central bankers. However, financial market developments have brought the question to the forefront of the policy debate. The continued integration and deepening of financial markets is a significant issue for policy-makers, and particularly for central bankers, since smoothly functioning and efficient financial markets are crucial in ensuring a smooth transmission of monetary impulses. Foreign Direct Investment Foreign direct investment influences economic growth by increasing the total factor productivity of the hosteconomy and generally by raising the efficiency ofresources in use in the host country. As mentioned earlier, local investment has little effect on the growth of the economy due to the zero sum game which occurs since any gains by an agent result in a loss by another agent. The points below display a brief comparison between the effects of foreign direct investment as opposed to domestic investment in an economy with a well-established financial market. Capital Markets A capital market is one in which individuals and institutions trade financial securities. Organizations and institutions in the public and private sectors also often sell securities on the capital markets in order to raise funds. Thus, this type of market is composed of both the primary and secondary markets. Any government or corporation requires capital (funds) to finance its operations and to engage in its own long-term investments. To do this, a company raises money through the sale of securities - stocks and bonds in the company's name. These are bought and sold in the capital markets.
- 15. 15 Stock Markets Stock markets allow investors to buy and sell shares in publicly traded companies. They are one of the mostvital areas ofa market economy as they provide companies with access to capital and investors with a slice of ownership in the company and the potential of gains based on the company's future performance. This market can be split into two main sections: the primary market and the secondary market. The primary market is where new issues are first offered, with any subsequent trading going on in the Secondary market. Bond Markets A bond is a debtinvestmentin which an investor loans money to an entity (corporate or governmental), which borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities,states and U.S. and foreign governments to finance a variety of projects and activities. Bonds can be boughtand sold by investors on credit markets around the world. This market is alternatively referred to as the debt, credit or fixed-income market. Money Market The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. Money market securities consistofnegotiable certificates ofdeposit (CDs), banker's acceptances, U.S. Treasury bills, commercial paper, municipal notes, and repurchase agreements (repos). Money market investments are also called cash investments because of their short maturities. The money market is used by a wide array of participants, from a company raising money by selling commercial paper into the market to an investor purchasing CDs as a safe place to park money in the short term. The money market is typically seen as a safe place to put money due the highly liquid nature ofthe securities and short maturities. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities. Cash or Spot Market Investing in the cash or "spot" market is highly sophisticated, with opportunities for both big losses and big gains. In the cash market, goods are sold for cash and are delivered immediately. By the same
- 16. 16 token, contracts bought and sold on the spot market are immediately effective. Prices are settled in cash "on the spot" at current market prices. The cash market is complex and delicate, and generally not suitable for inexperienced traders. The cash markets end to be dominated by so-called institutional market players such as hedge funds, limited partnerships and corporate investors. The very nature ofthe products traded requires access to far-reaching, detailed information and a high level of macroeconomic analysis and trading skills. Derivatives Markets The derivative is named so for a reason: its value is derived from its underlying asset or assets. A derivative is a contract, but in this case the contract price is determined by the market price of the core asset. If that sounds complicated, it's because it is. The derivatives market adds yet another layer of complexity and is therefore notideal for inexperienced traders looking to speculate. However, it can be used quite effectively as part of a risk management program. Examples of common derivatives are forwards, futures, options, swaps and contracts-for- difference (CFDs). Not only are these instruments complex but so too are the strategies deployed by this market's participants. There are also many derivatives, structured products and collateralized obligations available, mainly in the over-the-counter (non-exchange) market that professional investors, institutions and hedge fund managers use to varying degrees but that play an insignificant role in Private investing. Forex and the Interbank Market The interbank market is the financial system and trading of currencies among banks and financial institutions, excluding retail investors and smaller trading parties. While some interbank trading is performed by banks on behalfoflarge customers, mostinterbank trading takes place from the banks own accounts. The forex market is where currencies are traded. The forex market is the largest, mostliquid marketin the world with an average traded value that exceeds $1.9 trillion per day and includes all ofthe currencies in the world. The forex is the largestmarket in the world in terms ofthe total cash value traded, and any person, firm or country may participate in this market. There is no central marketplace for currency exchange; trade is conducted over the counter. The forex
- 17. 17 market is open 24 hours a day, five days a week and currencies are traded worldwide among the major financial centers of London, New York, Tokyo, Zürich, Frankfurt, Hong Kong, Singapore, Paris and Sydney. Until recently, forex trading in the currency markethad largely been the domain of large financial institutions, corporations, central banks, hedge funds and extremely wealthy individuals. The emergence ofthe internet has changed all of this, and now it is possible for average investors to buy and sell currencies easily with the click ofa mouse through online brokerage accounts. Conclusion and Recommendations As depicted in the paper, studies have shown that foreign direct investment in a country with a well- developed financial market contributes to economic growth at a higher rate as compared to local investment. It is however difficult to evaluate the magnitude of foreign direct investment on a host country, since the high growth rate might be as an influence of other unrelated factors. Also the crowding outeffect associated with foreign directinvestmentis yet to be clearly studied .Foreign direct investment also boosts domestic investment in that it creates an entrepreneurial effect in the local investors who imitate the new technologies advanced by foreign investment .In less developed economies with low educational, technological and infrastructure development, foreign direct investment has a relatively smaller effect on growth, commonly Characterized threshold externalities which include less developed financial markets. Governments especially in less developed countries need to enhance and develop robustfinancial markets in order to realize the full potential of foreign direct investment. Financial markets act as linkages between the foreign financial markets and the economy. With better managed financial markets, the spillovers from directforeign investmentare capable ofinfluencing great economic development in host countries. For a country to attract foreign directinvestmentit requires policies and mechanism that make it conducive for the investment. This includes human capital development, streamlining government bureaucracies, development of the financial markets to mirror the international financial markets which are competitive and devoid ofcorruption. Most developing and third world countries fail to provide these incentives to multinationals and foreign investors. Research Mythology: Works on secondary data. The term paper based on secondary data.