chapter 2- financial management environment

Macroeconomics

Concerned with issues affecting the economy as a whole eg economic growth inflation unemployment

Aims for economy

Economic growth

Control inflation

Balance of payments stability

Full employment

Balance of payments deficit

Where the cost of imports is higher than the revenue from exports

Can fix this by manipulating exchange rate to switch spending away from imports (expenditure switching policy)

Expansion macroeconomic policies

Adopted to increase demand (spending) in economy to stimulate economic growth

Contractionary macroeconomic policy

Required to keep inflation within acceptable limits and to decrease domestic spending on imported goods

Macroeconomic policies- fiscal policy (not mutually exclusive)

Involves using government spending and tax to manage demand to achieve macroeconomic targets by

Spending more/ less on services

Changing rate of direct/ indirect taxes

Macroeconomic policies- monetary policy

Aims to influence monetary variables eg interest rate and money supply to manage demand to meet targets

Changed to interest rate by gov affects borrowing cost of cos (variable rate)

Higher interest rates exert downward pressure on share prices so harder to raise money from share issues and less consumer demand

Macroeconomic policies- exchange rate policy

Gov may try to fix exchange rate (fixed rate pol)

Allow it to change in response to market forces (floating rate pol)

Take action to influence its value (managed exchange rate pol)

Lower exchange rate helps exporters

Contractionary vs expansionary

Contractionary- decreases demand

Expansionary- increases demand and increases growth and jobs

Lower exchange rate

Domestic goods cheaper demand for exports increases

Foreign goods more expensive so demand for imports decreases

Higher production costs

Higher exchange rate

Domestic goods more expensive in foreign market so demand for exports decreases

Foreign goods cheaper import demand increases

Costs of production decrease

Market failure

Said to occur when the market mechanism fails to work efficiently and outcome is suboptimal

Imperfect competition

Where one company’s large market share is leading to excessive profits stats may intervene to stimulate competition

Oligopoly

Where a few large field dominate the market

Monopoly

Where one large firm dominates the market

Usually any market share over 25%

Social costs

Impacts a 3rd party (not buyer or seller) of economic transaction

Negative externalities- affects society as a whole

May require regulations

Imperfect information

Where false info is being put into public domain and distorting consumer choice

Fairness

Gov may resort to regulation to improve social justice eg concerns about fairness of expensive housing

Competition policy

Gov regulation authority may be asked to investigate oligopoly situations and may do price cuts, price and profit controls or break up firm

Or prospective merger

Must decide if against public interest

Supply side policies

Eg competition policy

Aims to improve efficiency motivation and productivity

Corporate governance regulation

Tighter regulations imposed costs onto companies but increased confidence of investors and may benefit cos by making it easier to attract finance

Gov assistance for businesses

Grants may be available to attract firms to invest in depressed areas

Green policies

Failure of free market to recognise positive and negative externalities eg pollution may lead to gov action eg tax on petrol so polluter pays or create opportunities

2 routes to obtain finance

1. Directly from investors in financial market

2. Indirectly through financial institutions that investors have deposited their money in (act as financial intermediary)

Financial intermediary

Institution bringing together providers of finance and users of finance

Links lenders with borrowers by obtaining deposits from lenders and relending to borrowers

Institutional investors

Eg pension funds, insurance cos

Biggest investors in stock market

Benefits of financial intermediaries (MAP)

1. Maturity transformation- most important, borrowing money in shorter time frames than end out

2. Aggregation of funds- can aggregate smaller savings deposited by savers and lend on in bigger amounts

3. Pooling losses- decrease risk to individual lenders

Disintermediation

A decline in traditional deposit and lending relationships between banks and their customers and an I create in direct relationships between ultimate suppliers and users of financing

Securitisation

Securitisation

Ability of co’s to borrow by issuing debt securities eg loan notes

Or converting existing previously untradeable assets to marketable securities

Money market

Market for short term finance up to a year

Capital market

Markets for medium to long term finance over a year

Primary market

Where co’s issue new securities to investors to raise new funding

Secondary market

Where investors buy and sell from and to eachother

3 types of money market instruments

1. Interest bearing- instruments pay interest and investor receives face value + interest at maturity

2. Discount instrument- do not pay interest, traded at discount and redeemed at par value (discount= equivalent to interest and is difference between price of instrument and redemption price at maturity)

3. Derivatives- instruments derived value from another asset eg exchange or int rates

Annualised yield

Discount/ amount actually paid at start x100

Annual rate calc

(1+R) = (1+r)^n

R- annualised interest rate

r- period interest rate

n- no of periods in a year

Negotiable instruments

Traceable and can be sold before maturity

Interest bearing instruments

1. Money market deposits

2. Certificate of deposit

3. Repurchase agreement

Money market deposit

Very short term between banks

At rate banks lend to eachother (sterling overnight index average SONIA)

Certificate of deposit

Usually very large over a mil

Certificate of receipt of funds deposited for specific term and paying interest at specific rate on specific date

Repurchase agreement

Agreement of 2 parties where one agrees to sell instrument to other in agreed date for agreed price and simultaneously buy back at later date for higher price agreed in advance

Discount instruments

1. Treasury bill

2. Commercial paper

3. Bills of exchange

4. Bank bill

Treasury bill

Issued by Gov with maturities a month to a year

Commercial paper

Short term unsecured corp debt maturity up to 270 days

Usually issued by large orgs with good credit rating

Bills of exchange

IOU signed by customer can be sold to raise finance only for significant amounts

Bank bill/ bankers acceptance

Signed IOU sold by co to raise funds at discount but low risk to customer

Co pays bank arrangement fee bankers acceptance can be sold on market

Only for great credit score 100’s thousands

Uk capital markets

1. Stock market- for cos with full stock market listing

2. Alternative investment market- less regulated secondary market

Capital market instruments

1. Issuing share capital- risky as dividends don’t have to be paid

2. Issuing debt capital- loan notes etc more secure as interest has to be paid

Reverse yield gap

Usually debt is lower risk than equity investment but more usually dividend yield on shares is lower than interest yield on low risk debt

Can occur as shareholders may be willing to wait and accept lower returns in short term for increase in future

Or if firm is desperate to raise finance

Eurocurrency market

Involves borrowing funds / depositing funds into bank outside country of currency the funds are denominated for short term (usually 3 months)

Can be any currency

Eg uk co borrows 50k from uk bank- Eurodollar loan

Eurobond

Bond denominated in currency different from country of issue

Negotiable

Must consider exchange rate if long term currency loan

Fintech

Software and other modern tech used by companies to provide automated and improved financial services

Development in digital tech

Eg internet

Manage financial transactions eg online banking

Blockchain technology

Allows secure low cost database of transactions that automatically update to record new transactions

Enabled development of cryptocurrency

Crowdfunding

Let’s company access financing via online crowdfunding platform to pitch for finance from large no of potential investors

Peer 2 peer lending

Let’s cos borrow with investors who want to lend on online platform

Can be cheaper loan finance as no intermediary fees

Quicker - not in bank hours

Not usually available to start ups

Security token offering

Done using blockchain technology

Investor receives token eg share in exchange for payment made in cryptocurrency

Historically less regs than share issue so cheaper and quicker