¶ … functions of financial markets and discusses why a dollar tomorrow cannot be worth less than a dollar the day after tomorrow. Furthermore, the paper explains the cash flows associated with a bond to the investor. And discusses the term "price-earnings (P/E) ratio." In addition, the paper discusses the certainty equivalent approach to estimating the NPA of A project and discusses the problems associated with capital investment process. Lastly, the paper contrasts and compares capital budgeting and strategic planning assesses the agency problems associated with capital budgeting.
Explain the functions of financial markets
The existence of the financial market is just to help and maintain the relations between the users of the capital and the providers of the capital. They also provide an opportunity for both the parties to do transactions with mutual benefits. It is there so that the investor and the investment can do the business smoothly and at ease. They offer a pricing function for both the parties that mean both the seller and the buyer are provided with reasonable evaluation of assets in the financial markets. Then another point that has to be kept in mind is that the financial markets are properly regulated which further motivates the issuers of the securities to restrict the dealings that market thinks as unsafe to the worth of their assets. There are some particular needs of both the lenders and the borrowers and these needs cannot be dealt by these financial markets and so this is the reason why financial intermediaries exist. They work towards matching the complex requirements of both the parties which means they look for counterparties with precisely opposite needs as this will assist in decreasing the costs. The lenders want some safety as well as liquidity and they have a few wishes such as (Groz, 2009):
* The risk minimisation which means the minimization of the risk of non-payment which is that the borrowers don't meet their repayment requirements and the risk related to assets falling in worth (Groz, 2009).
* The cost minimisation (Groz, 2009).
* The maximisation of return which basically means that all the money invested by the lender is received back by him.
* The ease of changing a financial claim into cash without any loss of capital value this is Liquidity which lenders value.
Borrowers too have some wants (Groz, 2009):
* Funds at a specific time which is that the borrower would appreciate getting funds at his choosen date.
* Funds for a particular time period, most likely long-term for the reason that in order to have positive returns the funds can't be given back in the short-term.
* Funds at the least achievable cost which means low interest rates.
Direct finance and indirect finance have particular dissimilarities. There is an advantage to indirect finance over the direct finance however there are extra costs incurred like spread of interest rate and having additional fees when making use of the financial intermediaries. To announce that indirect finance is a lot more beneficial than direct finance it is necessary that the advantages of such activity offset the costs related with the indirect finance (Groz, 2009).
A dollar tomorrow cannot be worth less than a dollar the day after tomorrow
A minute's reflection can persuade you that the cash at present is always value more than cash tomorrow. If you do not trust me then provide me with the money now. I will give you back every penny of it in exactly 1 year (Taleb, 2008).
You'd be stupid certainly to let go food, attire, home, car and entertainment for 1 year for no payment whatsoever. That's the reason a dollar at present is valued more than a dollar tomorrow. (An additional rationale that a dollar at present is valued more than a dollar tomorrow is that, in current economies, for reasons explained in Chapter 17, Monetary Policy Targets and Goals, prices suppose to increase each year. So $100 in future will buy lesser goods as well as services than $100 at present will. Of inflation on the interest rates will be explained in detail at the conclusion of this chapter. Right now, we will discuss just the nominal interest rates, not actual interest rates.) But let's say you were told that if you provide me $100 at present, I'd provide you $1,000 in 1 year? Most providers would jump at this (provided they think I will pay as said and not run away), but...
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