Financial_Commercial_Papers

1. What is the definition of financial commercial papers' -Commercial paper consists of short-term, promissory notes issued by corporations. The maturiy ranges up to 270 days, but average roughly 30 days. Many companies use Commercial paper to raise cash for current transactions, and “many find it to be a lower-cost alternative to bank loans.” (Board of Govenors of the Federal Reserve System) 2. What type financial instruments are they' * A financial instrument is “A document (such as a check, draft, bond, share, bill of exchange, futures or options contract) that has a monetary value or represents a legally enforceable (binding) agreement between two or more parties regarding a right to payment of money. See also debt instrument, equity instrument, and financing instrument.” (Financial Instrument). Based upon the definition of financial commercial papers, bonds would be the financial instrument being used. 3. Compare the 3-month financial commercial paper rates and 3-month nonfinancial commercial paper rates from 1995 to 2005 (take monthly frequency). If there are any differences, what would be the source of the difference' Explain your answers clearly. Hint: Graphing the series over time may help you analyze them more easily. * Listed below are financial commercial paper rates and nonfinancial commercial paper rater from 1/1/1997 through 12/31/2005 respectively. Based the graphs listed below the difference is minimal. 4. What is the relationship between money supply and interest rates' * Money supply refers to how much capital exists in a market that an individual or business can use to engage in financial transactions. Interest rates are the “fees” associated with loans, whether to consumers or between commercial banks. In most economies, a central bank or government agency is responsible for watching over the money supply and interest rate and adjusting policies as necessary.” “Central banks can also influence consumer interest rates, which is the amount a bank will charge individuals and businesses for loans. This affects the money supply and interest rate because consumers having to pay more money from higher interest rates will reduce the money supply and create a tighter economic market. Raising interest rates is also a common way for the central bank to curb inflation in an economy. 5. Explain what happens to interest rates as money supply increases or drops. How does the Federal Reserve use this link to adjust interest rates' * “An increase in the supply of money works both through lowering interest rates, which spurs investment, and through putting more money in the hands of consumers, making them feel wealthier, and thus stimulating spending.” (Anna J. Schwartz) Business firms respond to increased sales by ordering more raw materials and increasing production. The spread of business activity increases the demand for labor and raises the demand for capital goods. In a buoyant economy, stock market prices rise and firms issue equity and debt. If the money supply continues to expand, prices begin to rise, especially if output growth reaches capacity limits. “As the public begins to expect inflation, lenders insist on higher interest rates to offset an expected decline in purchasing power over the life of their loans.” (Anna J. Schwartz) 6. Please compare the 3-month Treasury bill rates (monthly) the seasonally adjusted monthly M2 series between 1995 and 2005. Are the T-bill rate and money supply related' How (positive, negative or no relationship)' If they are related to each other, what are the possible reasons behind it' Explain your answer clearly. Hint: Calculate the monthly growth rate of M2 and compare it to T-bill rate. The FOMC buys and sells government securities to set the money supply. This process is called open market operations. The government securities that are used in open market operations are Treasury bills, bonds and notes. If the FOMC wants to increase the money supply in the economy it will buy securities. When the FOMC wants to decrease the money supply, they’ll sell securities. To increase the money supply in the market, the FOMC will purchase securities from banks. The funds that the banks acquire from the sale can be used as loans to individuals and businesses. The more money that is available in the market for lending, the lower the rates on these loans become, which causes more borrowers to access cheaper capital. This easier access to capital leads to greater investment and will often stimulate the overall economy. To decrease the money supply, the FOMC will sell securities to banks, which leads to money being taken out of the banks and kept in FOMC reserves. The decrease in money available in the economy leads to a decrease in investment and spending as the availability of capital decreases and it becomes more expensive to obtain. This limiting of access to capital slows down economic growth as investment decreases. Works Cited Anna J. Schwartz. (n.d.). The Concise Encylcopedia of Economics. Retrieved from What Is the Money Supply': http://www.econlib.org/library/Enc/MoneySupply.html Board of Govenors of the Federal Reserve System. (n.d.). Retrieved from About Commercial Paper: http://www.federalreserve.gov/releases/cp/about.htm Financial Instrument. (n.d.). Retrieved from BusinessDictionary.com: http://www.businessdictionary.com/definition/financial-instrument.html#ixzz2NRMnNx4m