Chapter 2 Financial Management Environment

1.
1.1 1.2 1.3 1.

Objectives
Briefly describe the types of government objectives for the economy. State the government policies which can be applied for macroeconomic targets. Explain the types and functions of financial institutions and financial intermediaries. Briefly describe the types of financial mar!ets and their main functions.
( in a n c ia l & anagem ent E n v iro n m e n t

& a c ro e c o n o m ic ' a rg e ts

" o v e rn m e n t % o lic ie s ' ypes

( in a n c ia l $n s titu tio n s

( in a n c ia l & a r! e ts

1 . E c o n o m ic " ro w th 2 . # o w $n f l a ti o n 3 . B a la n c e o f % a y m e n t S ta b ility

1 . ( is c a l % o lic y 2 . & o n e ta ry p o lic y 3 . E x c h a n g e ra te p o lic y

' ypes

( u n c tio n s

1 . & o n e y & a r! e ts 2 . ) a p ita l & a r! e ts 3 . E u ro m a r! e ts

. ) o m p e titio n p o lic y * . " re e n p o lic y

1 . & e rc h a n t B a n ! 2 . % e n s io n ( u n d s 3 . $n s u r a n c e c o m p a n ie s

1 . & a tu rity ' ra n s fo rm a tio n 2 . + g g re g a tio n o f ( u n d s 3 . % o o lin g lo s s e s

2.
2.1

Macroeconomic Targets
"overnment objectives for the economy are referred to as macroeconomic objectives or targets. 'he three main targets are usually, -a. Economic growth and high employment -b. #ow inflation -c. Balance of payments stability %olicies for achieving macroeconomic targets Policy type (iscal policy &onetary policy Exchange rate policy )ompetition policy "reen policy Definition /ow much the government decides to spend0 and to raise as tax revenue )ontrol over the money supply and of interest rates $f the value of the local currency is forced down in value it ma!es imports more expensive and exports cheaper %olicies to ta!eovers encourage competition0 e.g. bloc!ing

2.2

%olicies to encourage protection of the environment

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3.1

Financial !nstit"tions
'ypes of financial institutions Types &erchant ban!s %ension funds $nsurance companies F"nctions %rovide large corporate loans0 often syndicated. &anager investment portfolios for corporate clients $nvest to meet future pension liabilities. $nvest to meet future liabilities. #Dec $%&

3.2

(inancial intermediaries provide the following functions, F"nctions &aturity transformation Descriptions

+ ban! can ma!e a 112year loan -long2term. while still allowing its depositors to ta!e money out whenever they want3 so short2term deposits become long2term investments. + ban! can aggregate lots of small amounts of money into a large loan. &any individuals may be scared of lending money directly to one particular company because of that company going ban!rupt. + ban! will be lending money to many companies and will therefore be reducing the ris! to themselves and therefore to the individuals whose money they are using.

+ggregation of funds 4iversification of ris!

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.1 .2 .3

Financial Mar(ets
+ financial mar!et brings a firm into )irect contact *ith its investors. 'he trend to borrowing directly from investors is sometimes called )isinterme)iation. (inancial mar!ets are split into those that provide short2term finance - money mar(ets. and those that provide long2term finance -capital mar(ets.. Money mar(ets 5 $f a company or a government needs to raise f"n)s for short+term -usually less than one year.0 they can access the money mar!ets and issue, $ncreasing ris! to the investor -a. 'reasury bills -issued by governments. -b. )ertificates of deposit -issued by companies. -c. )ommercial paper -issued by companies with a high credit rating. -d. Bills of exchange

Capital mar(ets 5 $f a company needs to raise f"n)s for the long+term0 it can access the capital mar!ets3 this is a mar!et on which the following are traded, $ncreasing ris! to the investor -a. 4ebentures6loan notes -secured on an asset or by covenants. -b. 7un! bonds -unsecured. -c. Shares traded on the main stoc! mar!et -d. Shares in +lternative $nvestment &ar!et

.* .9 .: .;

/igher ris! investments re8uire a higher return to be paid0 so shares will give a higher return -and therefore cost more. than debentures. Commo)ity mar(ets 5 which facilitate the trading of commodities -e.g. oil0 metals and agricultural produce.. Derivatives mar(ets 5 which provide instruments for the management of financial ris!0 such as options and futures contracts. E"romar(ets 5 $n recent years a strong mar!et has built up which allows large companies with excellent credit ratings to raise finance in a foreign currency. 'his mar!et is organised by international commercial ban!s. -a. E"roc"rrency mar(ets 5 Eurocurrency is money )eposite) *ith a ban( o"tsi)e its co"ntry of origin0 e.g. money in a <S dollar account with a ban! in
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-b.

#ondon is Eurodollars. =ote that these deposits nee) not be *ith E"ropean ban(s0 although originally most of them were. Eurobond mar!et 5 + Eurobond is a bond denominated in a currency which often differs from that of the country of issue. $t is long2term loans raised by international companies or other institutions and sold to investors in several countries at the same time. 'he term of a Eurobond issue is typically 11 to 1* years.

1*

E,amination -tyle ."estions

."estion 1 4iscuss the role of financial intermediaries in providing short2term finance for use by business organisations. - mar!s. -+))+ (> (inancial &anagement 4ecember 211> ? -a..

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