Equity Market, Corporate Debt Market, and Derivatives Market - Assignment Example

Question 1. Equity market The equity market, also referred to as the stock market is the market where the companies sell their shares publicly to interested parties and are traded through over the counter or through the exchanges. In the equity market, both parties that is the company and the shareholders win because the company gains capital additional for running the business as the investors acquire a portion of the ownership of the company. The equity market is the most organized and dynamic component of the capitals market. This market plays various roles in a nation`s capital markets. It acts as a way of mobilizing individual savings of investors who trade in the capital market since they offer protection to the investors. It promotes the formation of capital which helps in the growth of a nation`s economy though deviation of the capital in the capital markets to appropriate investment avenues. Other functions of the equity market in the capital market include investment priorities, safety in investment, marketing the securities widely as well as act as an indicator of the industrial development. The stock markets are the main source of domestic capital markets as it helps to raise huge capital. It also helps in gaining customers or investors in international capital markets. Corporate debt market. This is also referred to as the corporate bond and it is a debt security which is issued by a company and then sold to the investors. Most companies raise capital through the capital bond to finance an ongoing operation or to expand their firm. Corporate bonds usually have a maturity period of at least one year. They are however considered to be risky and as a result, lead to its interest rate being even higher than the government bonds. Corporate bonds have per value and a standard coupon structure of payment in almost all bonds. The corporate bond are usually taxable. A well-developed debt market helps in the development of the economic welfare. It offers funds the state, the local and federal government need to kick off a project and also for development. The corporate bonds helps to reduce the cost of construction of infrastructure for new or existing businesses. They yield more returns then other instruments in the capital market of a nation and hence has a lot of benefits. There are some instances when the banks in a country cannot give out loans to businesses due to the prevailing economic situation. As a result, corporate bond markets issue the bonds which mature at a certain period of time to act as a substitute of the loan which one was to receive in a bank. Government debt market This is also referred to as the government bond and is famous because of its safe investment. It is issued by the government of a country to the public promising that it will pay on the maturity date, the face value as well as the interest gained during the period. Government bonds are usually helpful in regulating the money supply of a nation and execution of the monetary policy. The money obtained from the government bond are used to support the spending of the government for the specified period. The government bonds helps to decrease the chances of inflation in an economy as more money will leave the economy. Thus the capital market becomes stable. The government bonds are used to distinguish other bonds when measuring the credit risk. The government bonds usually help to regulate the credit risk, the currency risk as well as the inflation risk. Hence it keeps the capital market of a country running effectively without the risks associated with it. The taxing power of the government offers the bond a low risk and hence investors do not fear when investing in the government debt market. Derivatives market This is a financial market with certain assets whose values are determined by the value of some other assets called the underlying assets. These assets include the futures contracts, the forwards, options and the swaps. The derivatives market is usually classified into two; the over-the-counter derivatives and the exchange-traded derivatives. The investors in the derivatives market can select to operate the derivatives market as hedgers, arbitrageurs, speculators or margin traders, based on their motives to trade. Derivatives are used to implement the improvement of the market efficiency by transferring risks such as credit risk, market risk, and liquidity risk to parties who are willing to bear them. These markets contribute to market completeness where the investors are able to exploit all the opportunities that may exist in the capital markets. The derivatives market helps in the growth and development of capital markets. They enhance shareholder value by ensuring access to cheapest source of facts as well as providing alternatives to the market. Derivatives significantly increase the market liquidity in both the domestic and international capital markets. As a result the transaction cost is lower and the efficiency in doing business is increased. The derivatives market allows the integration of local markets with the global market, hence leading to more growth in the participating firms. Foreign exchange market. It is a market which is globally decentralized where the currencies of different countries are usually traded. The large international banks around the world are the main participants in the foreign exchange markets where they convert the country`s currency to another country’s currency. The market promotes liquidity as a result of its huge volume of trade in the world. This is essential to the ever growing capital market. This market operates continuously on a 24-hr basis due to the geographical dispersion of the foreign exchange market. In this market, the relative profit gained is of low margin as compared to the other markets explained above. The foreign exchange market enhances profitability by use of leverage. This market is also ideal for credit providing for international trade and this promotes the international capital markets. Some of the functions of the foreign exchange market in the capital market include providing hedging facilities to avoid the foreign exchange risk and transferring finance from one nation to another. Question 2. A corporate form of organization is a form of business created by some people with its rights and obligations being separate from the people involved in the formation. The following are the various characteristics of corporate form of organization; The corporate form of organization is easy to form since not many legal formalities are involved in its formation. It should be easy to form because organizations that have very many legal formalities lead to time consumption. The organization raises its capital in various ways which are less costly. It uses various methods such as the safety of investment, transferability of holding and fair investment return if it needs a large capital for its businesses or investment. Most corporate form of organizations either have unlimited or limited liability. A limited liability organization suggests that if the owner is unable to meet the business debts, his capital will be affected while on the other hand, for the unlimited company, personal assets will be taken from the owner so as to cover the unpaid debts. The corporate form of organization is structured in a unique way such that it has the management controlling the firm on behalf of the owners. For effective management to take place, the owners should be responsible for the management by being able to control the mangers any promoting a good agency relationship. The corporate form of organization is flexible in its operations. This means that the organization should be able to quickly respond to any changes in its operations and adopt to it without too much difficulty. This form of organization ensures continuity and stability of its business also by coming up with long term strategies and plans of the business development. The equity method of financing is where the company obtains capital for running its business by selling part of the company to the interested investors. The equity financing method is usually based on a long term financing strategy of the corporation. Most companies are sold in form of stocks where one stock is valued at a certain price. Once the investors buy the shares, they become shareholders and they obtain some control over the organization. The shareholders expect a huge return on investment at the end of the year or financial period. The corporate form of organization usually has various forms of equity funding strategies. One of the strategies is the venture capital firms which invest in the upcoming new coming industries. The venture capital firms are usually exposed to a lot of risks when they invest in new companies since there may be a high likelihood of the company collapsing. Therefore they expect huge returns by selling back those shares to the company and getting more profit. Alternatively, they sell those shares to the public on the stock exchange platform. The venture capital firms therefore invest in rising companies and have their own policies and obligations to be followed before choosing a company to invest in. on the other hand, the venture capital firms is one of the organization`s equity funding strategy as it has obtained the amount of capital it requires to develop. This method is called the private placement. Another method of equity financing is the public stock offerings. It is where the publicly listed companies sells its shares in the stock exchange market to the public with a motive of raising capital for investment and expansion. This method requires a long process of registration which makes it very expensive. The public stock offerings strategy is most appropriate for the companies that have matured well enough in the industry but not the new companies because this cost is a discouraging factor to the small companies. The offering price is preset and recognized by the company and the bank that handles the transaction. However the company that sells its shares in the stock exchange market is not required to pay back to the investors the capital in return of the shares. The public stock offerings also have its own disadvantages. Once the company goes public, it is required to disclose information that can be important to competitors. It is supposed to publicly report its performance at the end of the year. Investment banks usually act as the bridge where the investors are able to buy and sell shares of companies. A debt fund is a pool of investment like a mutual fund in which fundamental holdings are investments for fixed income. The main objective of investment in debt fund is to preserve capital and at the same time generate income. The debt funds usually have lower fee ratios as compared to the equity funds. This fee is lower due to the lower management cost. Most of the loans that is obtained from the finance companies are usually secured by an asset which acts as collateral. This means that the inability to pay the debt will lead to loss of the asset that secured the loan. The commercial banks offer small businesses with small loans for purposes of inventory which develops the company. One of the common methods of debt financing is the trade credit. This is where a supplier of the company allows it to delay in paying for the products or services rendered. This however depends on the suppliers themselves. This is an appropriate method because, the small company will be able to make profits and pay the suppliers. In some other instances, the owner may borrow a personal loan so as to fund his or her business. The debt fund strategies are also very important when financing on a long term basis. Most financial companies offer loans with a longer maturity period which helps the corporation to implement its long term projects. In debt funds, the lenders of the loans are the people who are more exposed to adverse risks than the investors. Some of the sources of private debt financing include banks, credit unions, friends, insurance companies, factor companies among others. Question 3. 1. Current ratio =  Current ratio = = 1.64 2. Quick ratio =  Quick ratio =  = 0.856 3. Cash ratio =  Cash ratio =  = 0.1466 4. Total asset turnover =  Total asset turnover =  = 1.12 5. Inventory turnover =  Inventory turnover =  = 7.24 6. Total debt ratio =  Total debt ratio =  = 0.377 7. Debt equity ratio =  Debt equity ratio =  = 0.61 8. Equity multiplier =  Equity multiplier =  = 1.61 9. Times interest earned =  Times interest earned =  = 16.197 10. Cash coverage ratio = earnings before interest and tax + non-cash expenses interest expense Cash coverage ratio = 5012500 + 559000/309482= 18.0 11. Profit margin =  Profit margin =  = 0.165 = 16.5 % 12. Return on assets =  Return on assets =  = 18.4 % 13. Return on equity =  Return on equity =  = 0.335 = 33.5 % Lower quartile Media n Upper quartile Co. performance Current ratio 0.5 1.43 1.89 1.64 Quick ratio 0.21 0.38 0.62 0.86 Cash ratio 0.08 0.21 0.39 0.15 Total asset turnover 0.68 0.85 1.38 1.12 Inventory turnover 4.89 6.15 10.89 7.24 Receivables turnover 6.27 9.82 14.11 Total debt ratio 0.44 0.52 0.61 0.38 Debt equity ratio 0.79 1.08 1.56 0.61 Equity multiplier 1.79 2.08 2,56 1.61 Times interest earned 5.18 8.06 9.83 16.197 Cash coverage ratio 5.84 8.43 10.27 18.0 Profit margin 4.05% 6.98% 9.87% 16.5% Return on assets 6.05% 10.53% 13.21% 18.4% Return on equity 9.93% 16.54% 26.15% 33.5% Current ratio–the current ratio of the company was lower than the upper quartile of the industry ratios. This means that the company`s ability to pay its liabilities is weak. The current ratio enables the creditors and investors to understand a company`s liquidity and its flexibility in paying its own current liabilities. Therefore the company has a negative ratio. A good current ratio is 4 which means that the business has four times its current assets than its current liabilities. Quick ratio – the company registered a higher quick ratio. This shows that the company has enough quick assets that will enable it to pay its current liabilities effectively. A higher quick ratio attracts the creditor`s interest as they want to know how soon the company will pay them back. Hence this ratio is positive for the company. If it had a lower ratio, it would reach a point where the company will be forced to use its capital assets to pay the creditors. Cash ratio – the company registered a ratio of 0.15. The ratio typically is suggested to be not lower than 1 since it represents the equality between cash and the current debt. Therefore the company`s ratio is negative because the company will be forced to find alternative means of paying its current debts other than cash only. Total asset turnover – this ratio should be high as shows how effectively the company has used its assets to produce a good. Our company generated a high ratio as compared to the industry and this is positive. However, to measure its effectiveness it should be measured with other companies in the same industry. Inventory turnover – a high ratio in inventory turnover represents a company`s ability to effectively control the merchandise it owns. It measures the liquidity of the company for investors to make a decision. The company showed a negative ratio as it reduced from 10 to 7. Receivables turnover- a higher ratio is more favorable as it shows that the company is able to collect the receivables effectively. Hence a high ratio shows that a company will pay its obligations sooner because the customers paid sooner. Total debt ratio–a business has to have twice as many assets as its liabilities for it to be stable and less risky. The lower the ratio the better since it shows less risk. Therefore the company`s debt ratio is positive. Debt equity ratio – for a company to be considered as stable, its debt equity ratio must be lower than that of the industry. 0.61 is lower to a considerable level and this shows that the company is stable. However, this ratio is negative because a debt to equity ratio of 1 shows that the stake holding of both creditors and investors is equal. For a positive debt to equity ratio to be implemented, the investors should have a larger shareholding than the creditors. Equity multiplier – the multiplier is supposed to be low as it shows that the company is not dependent on the debt financing so much. The company registered lower multiplier and is thus a positive move for the company. Times interest earned- the company registered a very high times interest earned and this means that the company is very stable in paying its interest rates when they fall due. The high ratio also protects the company from the credit risk. Hence this ratio is positive. Cash coverage ratio – this shows the company`s ability to pay the interest expense of a borrower. The company has a higher cash coverage ratio and as result it is considered to be positive since it is able to pay its interest expenses to the borrowers. Profit margin – the company experienced a higher profit margin which represents that it is positive since they are getting more profit. Most companies focus on getting high ratios. Return on assets – if the management effectively manages the assets available, they will produce more leading to a high ratio which shows that it is positive to the industry. Return on equity- higher ratios are usually better than the lower ratios. Therefore the return on equity is positive since the funds from investors are effectively used. References 1. Hamilton, Brian. Financing for the small business. U.S small business administration. 2. DeThomas, Art. Financing your small business: Techniques for planning, Acquiring, and Managing Debt. Psi research, 1992 3. Smith, Richard L. and Janet Kihilm Smith. Entrepreneurial finance. Wiley, 2000 4. McGee, Susan, corporate bonds set to blossom, the wall street journal. July 22 1998 5. HerveStolowy, Michel Lebas (January 2006) financial accounting and reporting: a global perspective. 6. Jones, Allen N. financial statements: when properly read they share a wealth of information. Memphis business journal, 5 February 1996 7. Casteuble, Tracy. Using financial ratios and assess performance. Association management 49, no. 7 July 1997. Read More