Background of Subprime Crisis The immediate cause or trigger of the crisis was the bursting of the United States housing bubble which peaked in approximately 2005-2006. High default rates on “subprime” and adjustable rate mortgages (ARM) began to increase quickly thereafter. An increase in loan incentives such as easy initial terms and a long-term trend of rising housing prices had encouraged borrowers to assume difficult mortgages in the belief they would be able to quickly refinance at more favorable terms. However, once interest rates began to rise and housing prices started to drop moderately in 2006-2007 in many parts of the U.S., refinancing became more difficult. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in the United States in late 2006 and triggered a global financial crisis through 2007 and 2008. Continue reading
Business Finance Concepts
Performance-Based Budgeting – Meaning, Working, Pros, and Cons
Performance-based budgeting has been the center of reforms in both the private and the public sectors. However, a substantial ambiguity still remains on how to define and implement performance-based budgeting. A somewhat close definition is that performance-based budgeting apportions resources in accordance with specific achievement or quantifiable results. Performance budgeting can also be defined as systems of planning, budgeting, and appraisal that focuses the link between budgeted funds and the expected outcome. Therefore, performance-based budgeting links measurable performance and allocation of resources, with the capacity to state the level of achievable output with the injection of additional resources. Nevertheless, the output can never be measured accurately. Performance budgeting is result oriented in that it holds different divisions accountable to specific performance standards. This form of budgeting enhances awareness of the kind of services expected by the taxpayer. This type of budgeting is flexible since it allocates resources in a lump sum Continue reading
Financial Leverage and the Shareholders Risk
It has is seen that financial leverage magnifies the shareholder’s earnings. It has also been observed that the variability of EBIT causes EPS to fluctuate within wider ranges with debt in the capital structure. That is, with more debt, EPS rises and falls faster than the rise and fall of EBIT. Thus, financial leverage not only magnifies EPS but also increases its variability. The variability of EBIT and EPS distinguish between two types of risk- operating risk and financial risk. 1. Operating Risk- Operating risk can be defined as the variability of EBIT (or return on assets). The environment- internal and external- in which a firm operates determines the variability of EBIT. So long as the environment is given to the firm, operating risk is an unavoidable risk. A firm is better placed to face such risk if it can predict it with a fair degree of accuracy. The variability Continue reading
Economic Value Added (EVA) Vs. Return on Investment (ROI)
Most of the companies employing investment centers evaluate business units on the basis of Return on Investment (ROI) rather than Economic Value Added (EVA). There are three apparent benefits of an ROI measure. First, it is, a comprehensive measure in that anything that affects financial statements is reflected in this ratio. Second, Return on Investment (ROI) is simple to calculate, easy to understand, and meaningful in an absolute sense. For example, an ROI of less than 5 percent is considered low on an absolute scale, and an ROI of over 25 percent is considered high. Finally, it is a common denominator that may be applied to any organizational unit responsible for profitability, regardless of size or type of business. The performance of different units may be compared directly to one another. Also, ROI data are available for competitors and can be used as a basis for comparison. The collar amount Continue reading
Value Added – Concept, Definition and Uses
Meaning and Definitions of Value Added The traditional basic financial statements are balance sheet and Profit & Loss account. These statements generate and provide data related to financial performance only. They do not provide any information which shows the extent of the value or the wealth created by the company for a particular period. Hence, there arose a need to modify the existing accounting and financial reporting system so that the business unit is able to give importance to judge its performance by indicating the value or wealth created by it. To this direction inclusion of Value Added statement in financial reporting system is useful. The Value Added concept is now a recognized part of the accountant’s repertoire. However, the concept of Value Added (VA) is not new. Value Added is a basic and broad measure of performance of an enterprise. It is a basic measure because it indicates Continue reading
Sources of Finance – Financing a New Business
In case of proprietorship business, the individual proprietor generally invests his own savings to start with, and may borrow money on his personal security or the security of his assets from others. Similarly, the capital of a partnership firm consists partly of funds contributed by the partners and partly of borrowed funds. But the company from of organization enables the promoters to raise necessary funds from the public who may contribute capital and become members (share holders) of the company. In course of its business, the company can raise loans directly from banks and financial institutions or by issue of securities (debentures) to the public. Besides, profits earned may also be reinvested instead of being distributed as dividend to the shareholders. Thus for any business enterprise, there are two sources of finance, viz, funds contributed by owners and funds available from loans and credits. In other words the financial resources Continue reading