Exercise 1
Definition of terms
|
Term
|
Meaning
|
Real World Application
|
|
Net Financial Wealth
|
The residue of all financial assets after
adjusting for claims against those assets (financial liabilities).
|
A corporation that owns only two assets of realty
worth $ 200 million and cash balance at bank of $ 50 million and owes
creditors to the tune of $ 40 million has a net financial assets wealth of $
210 million ($200m+$50m-$40m).
|
|
Liquidity
|
The ease which a financial asset can be
turned into cash without any significant impact on its value.
|
The 2008/9 financial crisis was caused by a
lack of liquidity in the financial market. Financial institutions found
themselves holding assets that they could not easily convert into cash. The
federal reserve responded to this problem by creating purchasing those toxic
assets. This act was meant to bring confidence in the financial market and
thereby create liquidity once more.
|
|
Credit
|
An arrangement where one party receives a
resource from another with a promise to repay in future.
|
A bank issuing a loan to a customer is a
typical example of real world application of the term credit.
|
|
Capital Markets
|
Markets that trade equity(stock) securities
and debt(bonds) instruments with maturities of more than one year
|
When an individual signs up for a 30 year
mortgage loan with a financial institution.
|
|
Money Market
|
Markets that trade debt securities or
instruments with maturities not exceeding one year.
|
When the U.S treasury issues one year
treasury bills (T-Bills).
|
|
Debt Securities
|
These are securities the issuance of which
creates debt obligations on the part of the issuer.
|
Bonds, Mortgages, Treasury Bills and Notes
alongside other instruments.
|
|
Price Indices
|
This is a measure of percentage changes in
a given set of prices.
|
The Consumer Price Index (CPI) is used to
measure the rate of inflation which is taken to be the percentage change in
the prices of a basket of goods and services.
|
|
Insider Trading
|
The act selling or purchasing securities
while in possession of material non-public information regarding those
securities.
|
The director who sold large numbers of his
stock holdings after receiving unpleasant news about the financial position
of the company. This came out in the case of SEC v. Adler, 137 F.3d 1325
(11thCir. 1998).
|
|
Bond
|
This is a long term debt obligation issued
by a corporation or a government unit in return for finance provided by the
holder. The issuer promises to pay a specific amount in the future.
|
The U.S government through the treasury
occasionally issue treasury notes. Similarly, state governments also issue
municipal bonds.
|
|
Financial Disclosure
|
The process of providing public access to
financial information.
|
Wealth declaration by those holding public
offices is an example of financial disclosure.
|
Sources of funds
Businesses can obtain funding from a variety
of sources but the three most important way are equity, debt or through
profits. Equity financing involves giving a portion of ownership of the
business to the providers of funds in return for their funds. It is the
cheapest form of raising external capital. Equity financing, however, gives
away the control of the company to the fund providers as their holding of
equity entitles them to contribute in governing the business.
In contrast, debt financing simply creates a
debt obligation towards the providers of capital. The major advantage is that
debtors do not acquire voting rights on account of the funds they have provided
to the business. This method is appropriate when the company does not want to
bring in additional owners by issuing new shares.
Lastly, a company can also finance its
activities through internal sources. This is majorly done through the ploughing
back the profits into the business instead of paying it out to shareholders by
way of dividends. Retained earning represents parts of a company profit not
paid out to its shareholders.
Exercise 2
Hedge funds
The 1998 rescue of Long-Term Capital
Management (LTCM) is a classic case that even hedge funds are vulnerable to
market fluctuations. For three straight years since its inception in 1994, LTCM
made good returns before trouble begun in early 1998(Edwards, 1999). The funds
equity had reduced to slightly below $ 30 million down from over $ 5 billion it
was. The partners must have taken very huge losses. LTCM mostly dealt in stocks
in across all industries. It problems, however, begun when Russia devalued its
currency and placed a moratorium on all sovereign debts which was worth $ 13.5
billion at the time. The case involved partners, investors and creditors. In
the end, it is the creditors who organized a rescue in return for stakes in the
fund’s equity. The LTCM case did not lead to any prosecutions.
Forecasting
Financial markets, like most other markets,
suffer from some level of uncertainty. It is this aspect that makes forecasting
very important for players in the financial markets. All players want to plan
their actions well in advance. Even speculators would like to operate with a
certain degree of prediction. Forecasting helps in achieving this as a planning
tool. In the acquisition of funds, players in the financial markets must work
with the knowledge that there are risks. Lenders want to be sure that their
debtors will not default. Similarly, borrowers want to be sure that the
interest rates will not change to make their loans very expensive. All this
uncertainty can be reduced by proper forecasting.
Exercise 3
The Truth in Lending Act
The Truth in Lending Act (TILA) was passed by
the Congress in 1968(Cross&Miller, 2012). As initially conceived, the
legislation simply required lenders to provide information relating to the
interest rates they were charging to their consumers. The rationale was to
facilitate informed decisions by the consumers as they could make comparisons
and choose the kind of product that suited their needs and ability to pay. Subsequent
amendments were incorporated in response to predatory lending practices by
lending institutions. Such practices were particularly prevalent in the
sub-prime mortgage market. Key
disclosures under TILA include the loan principle, the interest rate, the annual
percentage rate which is the actual interest on a yearly basis and all fees and
costs associated with the loan.
Financial regulation
I am now at that stage where one feels at
ease discussing basic financial and other regulatory reporting requirements. Much
of that transformation is attributed to my participation in this course. Any
discussion of the topic with colleagues would most likely capture the various
regulatory agencies. For instance, it would be appropriate to discuss the
Securities and Exchange Commission (SEC) and the reporting requirements for SEC
listed corporations. It would also be necessary to discuss the reporting
obligations under the Fed.
References
Cross, F.B. & Miller, R.L. (2012).The Legal Environment of Business, Text and
Cases: Ethical, Regulatory and
Corporate Issues, Eighth Edition.Mason, OH: South-Western Cengage.
Edwards, F.R. (2010).Hedge Funds and the
Collapse of Long-Term Capital Management. Journal of Economic Perspectives, 13(2),
189-210.
0 comments:
Post a Comment