Securitization forces banks to compete with institutional investors and other financial institutions for the business of prime borrowers. In response, banks are beginning to provide borrowers with a range of fee-earning services that facilitate the sale of debt instruments to investors. For example, banks offer borrowers note-issuing or underwriting facilities instead of loans and agree to help borrowers sell their debt instruments to investors as and when needed. Banks may also agree to purchase only the unsold portion of the debt issue. Thus, securitization is moving banks away from performing traditional banking functions, such as extending credit in exchange for periodic interest payments. In addition, securitization provides the creditor with two significant benefits. Because the lender can choose whether to trade the notes or to hold them to maturity, the lender can better manage its credit limits and asset portfolio. The bank also earns a major part of its income Continue reading
Financial Management Concepts
Baumol’s Sales Revenue Maximization Model
Sales maximization model is an alternative model for profit maximization. This model is developed by Prof. Boumol, an American economist. This alternative goal has assumed greater significance in the context of the growth of Oligopolistic firms. Baumol’s sales revenue maximization model highlights that the primary objective of a firm is to maximize its sales rather than profit maximization. It states that the goal of the firm is maximization of sales revenue subject to a minimum profit constraint. The minimum profit constraint is determined by the expectations of the share holders. This is because no company can displease the share holders. “Though businessmen are interested in the scale of their operations partly because they see some connection between scale and profits, I think management’s concern with the level of sales goes considerably further. In my dealings with them I have been struck with the importance the oligopolistic enterprises attach to the Continue reading
Behavioral Finance – Definition, Meaning, and Characteristics
Traditionally, economics and finance have focused on models that assume rationality. The behavioral insights have emerged from the application of insights from experimental psychology in finance and economics. Behavioral finance is relatively a new field which seeks to provide explanation for people’s economic decisions. It is a combination of behavioral and cognitive psychological theory with conventional economics and finance. Inability to maximize the expected utility (EU) of rational investors leads to growth of behavioral finance within the efficient market framework. Behavioral finance is an attempt to resolve inconsistency of Traditional Expected Utility Maximization of rational investors within efficient markets through explanation based on human behavior. For instance, Behavioral finance explains why and how markets might be inefficient. An underlying assumption of behavioral finance is that, the information structure and characteristics of market participants systematically influence the individual’s investment decisions as well as market outcomes. Investor, as a human being, processes Continue reading
Shareholder Value Approach
Nowadays shareholder value approach reflects to a modern management philosophy, which implies that an organization measures its success by enriching its shareholders. Shareholders or stockholders are individuals or institutions that owns in a legally form shares of a corporation. They are considered to be a subset of stakeholders, which are all individuals or communities, who have a direct or indirect interest in the business entity (e.g. suppliers, customers, government, competitors etc.). The philosophy of the shareholder value approach attempts to increase the organization’s value by enhancing firm’s earnings, by increasing the market value of corporation’s shares and by increasing also the frequency or amount of dividend paid. The idea is that shareholder’s money should be used to earn a higher return than it could by investing in other assets with same amount of money and risk. Furthermore according to many business analysts shareholder value approach provides managers with clear mission Continue reading
Working Capital Management – Definition, Significance, Objectives, and Importance
Working Capital is the part of the firm’s capital which is required for financing short term or current assets such as stock, receivables, marketable securities and cash. Money invested in these current assets keep revolving with relative rapidity and is being constantly converted into cash. These cash flows rotate again in exchange of other such assets. Working Capital is also called as “short term capital”. “Liquid Capital”, “Circulating or revolving capital”, The Working Capital management refers to management of the working capital or to be more precise the management of current assets and current liabilities. Working capital management is a very important to ensure that the company has enough funds to carry on with its day-to-day operations smoothly. A business should not have a very long Cash Conversion Cycle. A cash Conversion Cycle measures the time period for which a firm will be deprived of funds if it increases its Continue reading
Problems in Determination of Cost of Capital
It has already been stated that the cost of capital is one of the most crucial factors in most financial management decisions. However, the determination of the cost of capital of a firm is not an easy task. The finance manager is confronted with a large number of problems, both conceptual and practical, while determining the cost of capital of a firm. These problems in determination of cost of capital can briefly be summarized as follows: 1. Controversy regarding the dependence of cost of capital upon the method and level of financing There is a, major controversy whether or not the cost of capital dependent upon the method and level of financing by the company. According to the traditional theorists, the cost of capital of a firm depends upon the method and level of financing. In other words, according to them, a firm can change its overall cost of capital Continue reading