Functions and Roles of Capital Markets, Funding Alternatives Available to a Corporation - Term Paper Example

Capital Markets Student’s Name: Institution’s Name: Instructor’s Name: Course Code: Submission Date: Table of Contents Capital Markets 1 Introduction 2 2.2 The equity funding strategies and debt funding strategy 9 3.1 Calculations of ratios 10 References 15 Introduction Financial markets are markets that facilitate the buying and selling of monetary assets that includes stocks, derivatives, bonds and foreign currencies both domestically and globally. Financial markets enhance price stability, raise of capital, liquidity and risk transfer in a nation. The financial markets are comprised of capital markets and money markets. Capital markets facilitate the provision of long term funding; they play vital roles to a nation and are of different types as discussed below. Task 1 1.1 Capital markets Equity market Equity market refers to a market that deals with the issue and trading of shares via stock exchange market. It can be categorized into primary market and secondary market. The primary market deals with newly issued shares while secondary market deals with already issued shares. It facilitates transfer of shares from one shareholder to another easily. Equity market enable companies to access capital as investors also acquire part of the company ownership (Fabozzi and Peterson et al, 2009). The participants in equity market include; individuals, investors, banks, hedge funds among others. The buying and selling of their securities is completed by the nation’s stock exchange. The buying and selling of the securities can be done at an open outcry, where the exchange is physically performed on a trading floor or virtually, where the exchange is done electronically. However, this exchange involves the bidding process, whereby the exchange will take place upon the agreed price, between the buyer and the seller. This form of capital market facilitate the buying and selling of securities, by proving in time the exact exchange information as pertains to listed stocks. It allows companies to publicly trade and raise capital through the selling of shares to the general public (Graham and Smart et al, 2012). Corporate debt market The corporate debt refers to bonds issued by a company for the purpose of raising finance for different business operations. The corporate debt market is a market that deals with the issue, buy or sell of debt securities also termed as bonds. The corporate debt participants include institutional investors, individuals, government and traders. The bonds issued that last five years less are termed as short term corporate bonds, five years to twelve are intermediate and above twelve years are long term bonds. Corporation bonds are associated with high risks and high returns as compared to the government bonds (Fabozzi and Peterson et al, 2009). The interest rates paid to investors should be low when the credit quality of a corporate is high. The bonds to be issued can be convertible, callable or zero coupon bonds to enhance flexibility in the conversion of bonds to securities. Government debt market It’s a government market that deals with the issue and selling government bonds. The government bond is regularly dominated by the nation currency. The debt to be issued by the government should be issued with a pledge of periodic payment of interest and the value to be repaid when the debt reaches maturity. The government issues the treasury bills, whose maturity is less than a year, treasury notes; whose maturity is between two to ten years and treasury bonds whose maturity is over ten years. The debts can be issued both domestically and internationally (Fabozzi and Peterson et al, 2009). Foreign exchange market it’s a currency market that is decentralized globally to facilitate the exchange of currencies. It is the world’s leading market with key participants such as banks, central banks, hedge funds, forex and potential investors. There is existence of foreign exchange swaps, whereby the buying and selling of the matching units of a given currency are simultaneously exchanged for another having two dissimilar value dates. The foreign exchange swaps enable various companies with funds in varied currencies to easily and effectively manage them. The foreign exchange swaps is comprised of two transactions the spot and forward transactions, these should be performed simultaneously for equal quantities to facilitate an off set for each other (Graham and Smart et al, 2012). The forward foreign exchange should occur only when the involved companies both have the currency that each other requires, while the spot exchange transactions are just similar to forward in terms of agreement, however designed for in a particular date in the future mostly in the similar week. Derivative Market This refers to a financial market for derivatives; it deals with financial assets derived from other assets. This market is categorized into exchange traded and over the counter derivatives. Derivative can be defined as the contract that involves two parties, whereby the contract value is established by the prevailing changes in value of the fundamental asset. The underlying assets include equity, currencies and bonds. Most derivative contact are majorly traded over the counter, this means that the details as pertains to risk depth, collaterals and pricing is not provided to the public. The key participants in this market include hedgers, margin traders, arbitrageurs and speculators (Fabozzi and Peterson et al, 2009). The futures, options, swaps and forward contracts are categorized as derivatives. Since the investors may not be the owners of the original assets, but they can monitor and speculate on the price changes associated with the underlying asset under agreement with the other party. However derivatives are associated with inherent risks that are generally accepted to enhance participation in the market. Every derivative should be based on price, structure and risk of the primary asset. The price being a complex variable influences the investors to be buyers by taking long positions and sellers if they opt for short positions. Derivatives market aids the investors at hedging positions, speculate on the changes of assets, and enhance leverage and trading (McCormick, 2010). The capital markets facilitate the nation’s economic growth, the development of capital markets are thus vital for both domestic and international long term funding, since it creates a virtual market through computer networks thus making capital available for domestic and international investors (Levinson, 2014). 1.2 Functions and roles of capital markets Capital formation This is the major role played by the capital market in a nation economy. A capital market facilitates the mobilization of savings from savers and the funds are channeled to various industries and trade through different investors who borrow funds from the capital markets. It therefore leads to capital creation by creating a link to the flow of surplus and deficits units in an economy. Economic Growth and development Capital markets boost economic growth and development of a nation. The availability of funds for a long duration enhances capability of meeting business requirements. Also the financial and non financial institutions that function in capital markets offer a critical path to the movement of funds and balanced distribution of nation resources. Thus, the development of industry and commerce is improved leading to employment creation and infrastructure development (Fabozzi and Peterson et al, 2009). Investment Avenue Capital markets offer an investment venue to both savers and investors. It provides savers with incentives such as dividends and interests and the funds saved are transferred to the investors. Thus creating a market device through which funds can be saved and made available to those who need them for viable investment. It therefore, switches the nation resources from inefficient channels to industrious investments (McCormick, 2010). Security price stability Capital market is comprised of banking experts and other financial intermediaries, who aid at maintaining the value of stock and securities stable. The price stabilization is attained by lending capital at low interest rates and curtailing speculative actions in the market (Piketty and Goldhammer et al, 2014). Task 2 2.1 The various funding alternatives available to a corporation The corporation is business registered as per the requirements of the company act; it is required to operate as a legal separate entity from its founders. There are different funding alternatives available to the corporation to meet the financial needs as identified below. Equity financing The corporation that is listed in the stock exchange market is accessible to raising additional capital by the issue of shares through capital markets, since the market deals with both newly and already issued shares. The corporation quoted can raise both ordinary and preferences shares depending on the amount of capital required. The shareholders will only be entitled to receive dividends only when the profits are realized. This form of alternative funding is vital because it permanent in nature. Loan stock This is a long term source of finance, the corporation raises capital by issuing debt in form of stocks in which interest will be paid half annually on agreed fixed interest rate. The loan stock holders become the corporation long term creditors who shall be receiving interest at fixed rates. The loan stock is generally redeemable and is issued most for a period of more than ten years, the period of maturity should fixed by the corporation once matured they should be redeemed, by paying off the debt. Retained earnings These are profits generated and accumulated from recent financial periods. These profits can be used as an alternative funding in acquiring new assets and financing identified investment opportunities. This however will affect the dividends to be paid. The corporation considers this form of funding as an alternative because does not involve any cash expense and this should depend on the dividend policy of the corporation. Bank lending The corporation may obtain funds from lending institutions such as banks to provide short term, medium and long term financial assistance. The loan offered should be repaid within the specified period with the agreed fixed rate of interest payment. The corporation should seek long term loan to aid at meeting its long term financial needs and enable the corporation to make prior financial arrangements during loan repayment. Government assistance The corporation can seek financial assistance from the government. The government usually provides grants to corporations as a policy to economic development of nation. The corporation that its operations involve complex industrial technologies should seek financial assistance from the government if other alternative sources may not be adequate. 2.2 The equity funding strategies and debt funding strategy The corporation may need long term finance for expansion purposes, setting new projects, acquire or develop business premises. The funds may also be needed to research and develop new products. Through Hedge funds, various equity financing strategies can be adopted to facilitate identification of market opportunities and minimize risks as explained below. Long /short equity This is also referred as equity hedge. The long/ short equity strategies are applied at identifying undervalued and overvalued securities (McCormick, 2010). The managers can decide to buy securities deemed to be undervalued and equally trade short the securities considered overvalued. The fund should have an exposure to the stock market, for instance 40 % invested in short stocks and 60% on long stocks, and this means there is 20% general publicity of the stock markets, at this state the fund might not use some leverage. If the hedge manager wishes to increase long stocks to 90% and retain the short stocks at 40% then net publicity will be 50% with an operating leverage of 30%. Relative Value Arbitrage Fund managers adopt this strategy by buying securities that are anticipated to increase in value, while selling the short securities simultaneous whose value is anticipated to decline. The interrelated securities may be stock and bond of a given corporation; incase of two stocks from two dissimilar corporations in a similar industry or issue of two bonds in the similar industry of different coupons, in every case will give rise to the equilibrium value because the mentioned securities are allied however dissimilar in other components. In case the corporation has two bonds paying at 8% and 6% with expiry period of 30 years both, the 8% bond will pay higher and will sell at higher premium than 6% bond. The time the 6% bond is traded at bar the 8% bond will be trading at a premium. The premium amount is out of equilibrium, thus forming an opportunity for the hedge fund, to exploit the returns arising from the momentary value differences (Graham and Smart et al, 2012). Debt financing strategy There are various strategies available under debt financing for instance convertible debentures, bond placements, development bonds, buyouts and loans. The loan are the most debt financing used by corporations, because the loans to be obtained should match with financial need. The short term loans are acquired to finance to short term financial needs that last for less than a year. The long terms loans are acquired to finance long term needs of the company, which lasts for more than a year. The loans obtained don’t transfer part of the corporation ownership to the lenders however during loan repayment interest should be paid at fixed rate. Task 3 3.1 Calculations of ratios Current ratio This is the ratio that measures the liquidity position of the firm. Current ratio = current assets/current liabilities =3,027,211/1,842,090 =1.6: 1 Quick ratio= Cash + Accounts receivable Current liabilities  270,011+ 1,307,000 1,842,090 =0.86:1 Cash ratio= Cash + Cash equivalents Current liabilities 270,011+ 0 1,842,090 =0.15:1 Total asset turnover = Net sales / total assets =17,120,000/ 13,520,171 =1.267 Inventory turnover = Cost of Goods Sold ÷ Average Inventory = 10,500,000 ÷ 1,450,200 = 7.24 times Total debt ratio = Total liabilities Total assets = 1,842.090/ 13,520,171 = 0.136×100 =13.62% Debt–equity ratio= Total liabilities/ shareholders equity =1,842,090/ 8,419,081 = 0.22:1 Equity multiplier = Total assets/ shareholders equity = 13,520,171/ 130000 =104 Times interest earned = EBIT Interest expense = 5,012,500/309,480 =16.2 times Cash coverage ratio = EBIT + Non-Cash Expenses Interest Expense 5,012,500+559,000 309,480 =18 Profit margin= Net income/ net sales = 2,821,812/17,120,000 =16.5% Return on assets = net income/ total assets 2,821,812÷13,520,171 =20.87% Return on equity = net income/ stockholders equity = 2,821,812/8,419,081 = 33.5% 3.2 Comparison of performance of Tassie ratios to industrial ratios The current ratio indicates the liquidity position of Tassie; it has more assets than liabilities which can be used to settle debts. The ratio is good because it’s above the industrial ratio. The quick ratio for Tassie is high as compared to the industrial ratio, thus indicating that the company has adequate assets to be transformed into funds and settle bills. The cash ratio compares the company liquid assets against the liabilities. The cash ratio for Tassie is below average when with the industrial ratio, this indicates that the company may not be in a position of meeting short term obligations when falls due (Albrecht and Stice et al, 2011). The total asset turnover ratio is 1.267 in Tassie, which is above average when compared to industrial ratio. This shows that the company is capable of utilizing its assets more efficiently to generate sales. The inventory turnover for Tassie indicates that inventories can be turned into sales 7.24 times, which is average as compared to the industrial ratio. The total debt ratio draws comparison between the company‘s debt and the available assets. There is high percentage of debt ratio in Tassie Company, indicating its high dependence on leverage. In relation to the industrial ratio the company is at high risk. The debt equity ratio is below the industrial ratio, indicating that Tassie leverage ratio is good. Also the equity multipliers for Tassie high as compared to industrial ratio, this indicates that the company uses much debt to finance the assets (Fabozzi and Peterson, et al, 2009). The ratio of times interest earned is 16.2 times, this indicates that Tassie company can pay interest expense 16.2 times, which is high than the industrial ratio hence favorable. The cash coverage ratio is 18; this indicates the company has adequate cash available to pay off the interest expenses. The ratio is higher compared to the industrial ratio indicating the capability of Tassie at meeting interest expense when falls due. The profit margin of Tassie is 20.87%, which is greater than the industrial margin. This indicates positive profitability performance. The ROA ratio is higher as compared to industrial ratio. This indicates that Tassie ltd is highly profitable and assets are effectively utilized for profit generation. The ROE is good as the income percentage of owners wealth is high and above the industrial percentage. This indicates effective utilization of shareholders equity (Peterson and Fabozzi, et al, 2012). Conclusion The nation with less superior and poorly established capital markets will affect the utilization of monetary resources negatively. This shall affect the nation economy as many resources shall be wasted, through the capital markets the resources will be pooled and channeled to appropriate investments. The nation should therefore develop its capital markets in order to facilitate both domestic and global investments, to enhance the nation with accessibility to foreign exchange thus leading to economic development and creation of employment opportunities. References Albrecht, W. S., Stice, E. K., & Stice, J. D. (2011), Financial accounting. Mason, OH, South- Western/ Cengage Learning. Chartered Institute for Securities & Investment., & BPP Learning Media (Firm). (2013). Chartered Institute for Securities & investment: Level 3. Fabozzi, F. J., & Peterson, D. P. (2009). Finance: Capital markets, financial management, and investment management. Hoboken, N.J: Wiley. Graham, J. R., Smart, S. B., & Megginson, W. L. (2012). Introduction to corporate finance. Australia: South-Western/Cengage Learning. Levinson, M. (2014). The Economist guide to financial markets: Why they exist and how they work. New York: Public Affairs. McCormick, R. (2010). Legal risk in the financial markets. Oxford [England: Oxford University Press. Peterson D, P., & Fabozzi, F. J., 2012. Analysis of financial statements. New Delhi, PHI Learning Pvt Ltd. Piketty, T., & Goldhammer, A. (2014). Capital in the twenty-first century, South- Western/Cengage Learning Read More