International Business Finance - Essay Example

International Business Finance Task Table of Contents Table of Contents 2 Introduction 3 Shares 3 Factors influencing the return on shares 5 Corporate Bonds 6 The current economic climate 7 Conclusion 7 Reference List 8 Introduction Every investor puts his money in security that promises to generate returns. A return is therefore, a reward to investors for making an investment. There are several securities in which to invest.the following are some of the securities: shares, government bonds and corporate bonds. Generally, the choice of the security by an investor is partly influenced by an investor’s attitude towards risk. The following are the three attitudes toward risk: risk averse, risk indifference and risk takers. This essay is primarily based on the critical analysis of investing in bonds and shares in the current economic climate. Shares Ordinary shares- from the point of view of a company, they are sold to the public in order to raise share capital. The buyers of the shares sold by a company are referred to as the shareholders. Issuance of shares is therefore a method of financing a company’s operations. This finance is exclusively available to limited companies. It is a permanent finance as the owner/shareholder cannot recall this money except under liquidation. It is thus a base on which other finances are raised. The return on ordinary shares are variable. Shares carry voting rights and can influence a company’s decision-making process at the annual general meeting. Shares carry the highest risk in a company due to the following reasons: first, the return on shares are uncertain. Second, a refund cannot be guaranteed. Third, shareholders have residual claim (Khan & Jain 2007, pp. 20-29). Investing in shares buys the following rights to the shareholders: the right to vote in the election of the Board of directors; the right to residual assets claim; the right to amend the company’s by-laws; the right to appoint another auditor; the right to approve a merger acquisition; and the right to approve payment of dividends. Therefore, an investor who would wish to enjoy the following rights would better invest in shares. It is a major risk to invest in shares but despite the risk, shares are still attractive due to the following reasons: they are used as securities for loans ( a compromise of the market price of a share); their values grow and there is no limit to the level of growth; they are transferable at capital gain; they influence the company’s decisions; they carry variable returns and are best during high profitability season; they constitute a perpetual investment thus a perpetual return; and they can be used as guarantees for credibility (Hussey & Ong 2005, pp. 1386-142). Needless to mention, companies would appreciate if investors buy shares for the following reason: they use proceeds from the purchase of shares to facilitate projects especially long-term project for the reason that shares are permanent sources of finance; the cost of shares is not a legal obligation to the shareholders; using shares as a source of finance lowers the gearing level, thus reduces the chances of liquidation; the proceeds from the sale of shares is used with flexibility (no preconditions); lastly, using shares as a source of finance boosts a company’s credibility and credit rating (Choudhry 2010, pp. 182-189). Preference shares- this is another type of shares that investors should consider. It is also called quasi-equity for the reason that it combines features of ordinary shares and those of debt. It is called preference because it is preferred to ordinary shares in the follows ways: preference shareholders are given the first priority in dividend payment; and the preference shareholders are paid the proceeds from assets in case a company goes under receivership (Flynn 2005, pp. 19-25) Unlike the ordinary shares, the preference shares have a fixed return. They carry no voting rights. In addition, it is an unsecured finance thus, increases the gearing level of a company. This type of shares exists under various classifications as follows: redeemable preference shares, irredeemable preference shares, non-participative preference shares, cumulative preference shares, non-cumulative preference shares, convertible preference shares and non-convertible preference shares (Swart 2002, pp. 149-156). Factors influencing the return on shares Investors earn return on shares in form of dividends. The level of dividend per share is dependent on the level of a company’s profitability. Therefore, any factor, internal or external, that affects the level of a company’s profitability also affects the dividends thus, the return on shares. The following are some factors that influence return on shares: the level of economic activity (GDP), the interest rate, and internal operations (Chance & Brooks 2010, pp. 7-11). First, the level of economic activity in a country as measured by the gross domestic product influences the return on shares of a company. Any functional company is located in a country. The productivity level in a country is greatly contributed to by the aggregate productivity level of companies in a country. Therefore, if the a company is experiencing a low economic activity, it could mean that the rate of production of goods and services by the companies in that particular country is low. Other factors held constant, a low productivity level by companies translate to low sales level, thus low revenue level (Hu & Li 1998, pp. 8-10). In a company’s income statement, the revenue is subject to cost of sales and other operating costs, which reduce the revenue to obtain the net profit. Consequently, the profits attributed to a company will also be low. Since the equity shareholders have residual claim, they might either earn low dividend or earn no dividend depending on the levels of financial obligations to a company. On the other hand, a higher level of economic activity would mean the reverse of the above arguments (Brigham & Daves 2012, pp. 104-111). Second, the level of interest rate influences the return on shares as described. Companies depend on various sources of finance such as debt, equity, bank overdrafts and others. Interest rates are controlled by a country’s central bank (Bank of England). Creditors (Local and International Institution, individuals and government agencies), require reward for providing funds. These rewards are referred to as interest. Interest are costs to companies. Since most companies have a mixed capital structure (debt, equity and any other), the cost of debt will still affect the shareholder return for the reason that the interests are paid from a company’s operating profit before interest and tax (Organización para la Cooperación y Desarrollo Económicos 2008, pp. 187-189). If the government increases the interest rate, the cost of capital will increase. This means that a company will pay higher interest on debt. An increase in the interest expenses reduces the level of profit before tax thus, total profit. Since the equity shareholders have residual claim, they might either earn low dividend or earn no dividend depending on the levels of financial obligations to a company. On the other hand, if the government were to reduce the level of interest rates, the reverse of the above arguments would occur (Reilly & Brown 2012, pp. 349-357). Third, internal operations- a company’s internal operations regarding costs reduction strategy are an important factor when determining the profitability level. A company whose operating cost reduction strategy is inefficient, leading to a low profitability level due to high operating costs. High operating costs, reduce the profitability level of a company. Low profitability translates to low earnings to shareholders. On the other hand, a company with efficient operating cost management strategy exhibits the reverse of the above argument (Madura 2007, pp. 706-709). Corporate Bonds It is an investment method which involves the purchase of bond certificate, issued by a company, by an investor for the stated price and for a certain period referred to as maturity. The company (the bond issuer), in return, pays a certain amount of interest (coupon). For this type of investment, the returns, determined by the coupon rate, are constant till the bond matures. The maturity period of a bond is the time when both the principal and last interest earned on the bond are paid to the purchaser (an investor). Although corporate bonds are considered a safer investment than shares, they have some element of risks such as interest rate, credit risk and inflation rate. First, an increase in the rate of inflation reduces the value bonds. Second, an increase in interest rates reduces the earnings from a bond. Third, a company might fail to pay bond obligations on maturity (Bonds 2014, par. 1-13). The current economic climate Countries are still recovering from the recent economic crisis with most still experiencing slow economic growth. This means the level of productivity is still low in most countries. The current economic climate, thus adversely affects investment in shares than it does investments in bonds. Based on the fact that bonds have proven to be a better investment option than shares, it is still a better option for the reason that low level of productivity caused by the recent economic decline still clouds the performance of most companies. Economic analysts state that it will be long before a full economic recovery is experienced. For that reason, to be able earn stable returns, investors should consider corporate bonds (Shares or bonds- which is a better investment? 2012, par. 1-6). Conclusion The returns on shares are influenced by factors such as the level of interest rates, economic performance and the efficiency of a company’s internal efficiency. Corporate bonds also face risks such as credit, interest rates and inflation rate. Based on the fact that bonds have performed better than shares in terms of returns and that returns on shares have been adversely affected by the recent economic decline, it is advisable for investors to continue investing in bonds in order to earn constant returns. Reference List Bonds 2014, Viewed 2 May 2014, < https://www.sorted.org.nz/a-z-guides/bonds>. Brigham, E. F., & Daves, P. R 2012, Intermediate financial management. Mason, Ohio, South-Western. Chance, D. M., & Brooks, R. E 2010, An introduction to derivatives and risk management. Mason, Ohio, South-Western Cengage Learning. Choudhry, M 2010, An introduction to bond markets. Chichester, West Sussex, Wiley. Flynn, D 2005, Fundamental accounting. Kenwyn, Juta. Hu, Z., & Li, L 1998, Responses of the Stock Market to Macroeconomic Announcements Across Economic States. Washington, D.C., International Monetary Fund. Hussey, R., & Ong, A 2005, International financial reporting standards desk reference: overview, guide and dictionary. Hoboken, NJ, Wiley. Khan, M. Y., & Jain, P. K 2007, Financial management. New Delhi, Tata McGraw-Hill. Madura, J 2007, Introduction to business. Mason, OH, Thompson/South-Western. Organización para la Cooperación y Desarrollo Económicos 2008, OECD economic surveys. Paris, OECD. Reilly, F. K., & Brown, K. C 2012, Investment analysis and portfolio management. Mason, Ohio, South-Western Cengage Learning. Shares or bonds- which is a better investment? 2012, Viewed 2 May 2012, < http://www.stockopedia.com/content/shares-or-bonds-which-is-a-better-investment-64123/>. Swart, N 2002, Personal financial management. Lansdowne, Juta. Read More