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International financial markets - Essay Example

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In order to be able to operate, a firm needs capital to purchase inventory and equipment, pay its personnel, utilities, and other necessities, and in general acquire what is needed to produce the good or service that make up its sales. Long-term funds must therefore be raised,…
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Download file to see previous pages Bonds and stocks are types of securities, and they are each related to a different set of circumstances that govern the relationship between investor and investee.
Financing through stocks and bonds is a delicate matter for a company because it impacts on the firm’s rate of return as well as financial risk. Financing through equity usually has a higher cost of capital, because equity holders are entitled to a pro-rata share of the profits. Theoretically, therefore, stockholders’ expected returns have no limit. However, since the stockholders are not entitled to any returns if the company incurs losses, then there is no default risk associated with equity. On the other hand, debt capital entails a cost of interest to the borrower-firm. Interest rates associated with long-term debt are lower than the cost of equity to the firm, because debt is contracted at a fixed rate and is therefore limited to that rate, even though the firm earns much higher rates of income. There is a risk, however, associated with the possibility of default. Even if the firm incurs losses, its obligation to pay interest on its debt is fixed, therefore its inability to meet with interest payments may incur for it costly penalties.
The nature of the firm’s business affects the firm’s ideal capital structure – that is, the proportion of the needed capital it may finance through debt and through equity. The following are examples of industries and their average debt and equity ratios. It may be noted that companies in the same business do not necessarily have the same capital structures. For instance, in the consumer non-cyclical industry, Starbucks is financed entirely by equity, while Kellog relies slightly more on debt financing rather than equity.
Raising money from the bonds market. Large corporations could raise money through the bonds market. The process involves the underwriting of the bonds float by either one or several ...Download file to see next pagesRead More
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