Essay on Relationship between interest rate and global financial markets Cambodian Economist Journal, Vol.

1, Issue: 002 LONG KimKhorn, PUC, MA.IRs, ID: 61283 January 18, 2013 There are both relative and crucial relations between interest rate and the global financial market but before we can define these relationships, we have to understand what is interest rate and global financial markets first. There are at least two paradigms of thoughts between economist and financer, in which, for economists determine the characteristics of interest rate broader not even just pure rate from amount of loan but economical interest rate. As for financers, in general, define interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. Particularly, the interest rate (I/m) is a percent of principal (I) paid at some rate (m). Generally, interest rates are normally expressed as a percentage of the principal for a period of one year. In the past 200 years ago, rates have been variously set either by national governments, financial institutes and central banks. For example, the Federal Reserve federal funds rate in the United States has varied between about 0.25% to 19% from 1954 to 2008, while the Bank of England base rate varied between 0.5% and 15% from 1989 to 2009, and Germany experienced rates close to 90% in the 1920s down to about 2% in the 2000s. During an attempt to tackle spiraling hyperinflation in 2007, the Central Bank of Zimbabwe increased interest rates for borrowing to 800%. The start of 20th century along with unrest technological development, money not just traded by its traditional means, such as cash-in-cash, but virtually in a new type of market called global financial market in which investor and entities can trade globally financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand from surplus units to deficit units through many types of financial tools including security, stocks or bonds, by many constituents of financial market such as: (1) Primary market: Primary market is a market for new issues or new financial claims. Hence its also called new issue market. The primary market deals with those securities which are issued to the public for the first time; (2) Secondary market: Its a market for secondary sale of securities. In other words, securities which have already passed through the new issue market are traded in this market. Generally, such securities are quoted in the stock exchange and it provides a continuous and regular market for buying and selling of securities; (3) Money market: Money market is a market for dealing with financial assets and securities which have a maturity period of up to one year. In other

words its a market for purely short term funds; (4) Capital market: A capital market is a market for financial assets which have a long or indefinite maturity. Generally it deals with long term securities which have a maturity period of above one year. Capital market may be further divided in to: (a) industrial securities market (b) Govt. securities market and (c) long term loans market; (5) Debt market: The market where funds are borrowed and lent is known as debt market. Arrangements are made in such a way that the borrowers agree to pay the lender the original amount of the loan plus some specified amount of interest; As well as, (6) Euro Bond market: A market where bonds are denominated in currency other than that of the country in which they are issued is called euro bond market. Euro- Bond market is international in character. A striking characteristic of euro-bond market is that bulk if these bonds are denominated in dollars; (7) Equity markets: A market where ownership of securities are issued and subscribed is known as equity market. An example of a secondary equity market for shares is the Bombay stock exchange; (8) Financial service market: A market that comprises participants such as commercial banks that provide various financial services like ATM. Credit cards. Credit rating, stock broking etc. is known as financial service market. Individuals and firms use financial services markets, to purchase services that enhance the working of debt and equity markets; (9) Depository markets: A depository market consist of depository institutions that accept deposit from individuals and firms and uses these funds to participate in the debt market, by giving loans or purchasing other debt instruments such as treasure bills; (10) Non-Depository market: Nondepository market carry out various functions in financial markets ranging from financial intermediary to selling, insurance etc. The various constituencies in non-depositary markets are mutual funds, insurance companies, pension funds, brokerage firms etc. By combining the overall definition between interest rate and global financial market, we can conclude that financial markets are a market in which the virtual forms of money were traded by many types of market virtually and as we have known that from time to time as well as from one transaction to another, Interest rate has changed due to some factors such as(1) Political short-term gain in which lowering interest rates that can give the economy a short-run boost. Under normal conditions, most economists think a cut in interest rates will only give a short term gain in economic activity that will soon be offset by inflation. The quick boost can influence elections. Most economists advocate independent central banks to limit the influence of politics on interest rates; (2)Deferred consumption in which when money is loaned the lender delays spending the money on consumption goods. Since according to time preference theory people prefer goods now to goods later, in a free market there will be positive interest rate; (3) Inflationary expectations in which most economies generally exhibit inflation, meaning a given amount of money buys fewer goods in

the future than it will now. The borrower needs to compensate the lender for this; (4) Alternative investments in which the lender has a choice between using his money in different investments. If he chooses one, he forgoes the returns from all the others. Different investments effectively compete for funds; (5) Risks of investment in which there is always a risk that the borrower will go bankrupt, abscond, die, or otherwise default on the loan. This means that a lender generally charges a risk premium to ensure that, across his investments, he is compensated for those that fail; (6) Liquidity preference in which people prefer to have their resources available in a form that can immediately be exchanged, rather than a form that takes time or money to realize; (7)Taxes in which because some of the gains from interest may be subject to taxes, the lender may insist on a higher rate to make up for this loss. We can observe that no matter interest rate changed by what causes but its really influence/ change the financial markets domestically and globally because financial trade means trade money as in its virtual forms and so when interest rate change, global financial markets change. But the question is what kinds of change of interest rate related to financial market. Well, here are some examples that prove interest rate as the matter of life or death of financial markets because it affects the functions of markets both intermediary and financial functions. Intermediary Functions: (1) Transfer of Resources in which what degree/level that financial market can facilitate the transfer of real economic resources from lenders to ultimate borrowers; (2) Enhancing income in which how much financial markets can allow lenders to earn interest or dividend on their surplus invisible funds, thus contributing to the enhancement of the individual and the national income; (3) Productive usage in which how financial market can allow for the productive use of the funds borrowed enhancing the income and the gross national production; (4) Capital Formation in which how financial market can provide a channel through which new savings flow to aid capital formation of a country; (5) Price determination in which how financial markets can allow for the determination of price of the traded financial assets through the interaction of buyers and sellers. They provide a sign for the allocation of funds in the economy based on the demand and supply through the mechanism called price discovery process; (6) Sale Mechanism in which how financial markers can provide a mechanism for selling of a financial asset by an investor so as to offer the benefit of marketability and liquidity of such assets; (7) Price determinants in which how financial market can allow for the determination of price of the traded financial asset through the interaction of buyers and sellers to provide a signal for the allocation of funds in the economy based on the demand and supply through the mechanism called price discovery process; (8) Information in which to show the activities of the participants in the financial market result in the generation and the consequent dissemination of information to the various segments of the market. Financial

Functions: (1) Providing the borrower with funds so as to enable them to carry out their investment plans; (2) Providing the lenders with earning assets so as to enable them to earn wealth by deploying the assets in production debentures; (3) Providing liquidity in the market so as to facilitate trading of funds. In conclusion, interest rate is a key to determine and shape the global financial markets that every investor, government, financial institutes and central bank can not over look because if the financial market projected in good health, it helps the economy to mobilize the saving from the savers or surplus units such as household individuals, business firms, public sector units, central government and state government to deficit units in order to boost local investment, foreign direct investment (FDI), entrepreneurship growth, industrial development and for the gross domestic products (GDP) as whole or otherwise it can lead to global financial crisis like the last 2008 in United States and impacted very badly to overall global economic growth or even worst such as Euro Zone Crisis recently resulted by Greeces public ceiling debt.