Fin Understanding

Understanding the Concepts

Fin 100 Introduction to Finance

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1. Imagine you are a small business owner.
2. Determine the financial ratios that are important to the business.
3. Compare your ratios with those that are important to a manager of a larger corporation.

As a business owner, financial understanding is something that has to be studied before you decide that you are going to open or even start a new business. Small businesses in general run the finance operations of their business in a different way than the larger corporations.

Most of the small businesses must rely on the personal investors or personal resources to access money needed to be a successful business. It does not matter if it is a small business or a corporation; being a successful business depends on having the capability to make more than what is being paid out. Now that we have a little understanding of what it will take to start the business; we must have knowledge of the different types of ratios that will help us with this. The main three ratios that are used in the business world are the current ratio, total debt ratio, and profit margin.

The current Asia is a measure of the company ability to pay off its short-term debt as it comes due (Melcher & Norton). This ratio is computed by dividing the current assets by the current liabilities. Total debt ratio is Just what you think it is; the total amount of debt the company has. The total debt ratios are total debt or total liabilities of the business and divide it by the total assets. Profit margin is simply how much profits (money) is made during the operation or while the business was open if you had to close it down.

Net income is divided by sales in order to show the profit. All of the three ratios are used to no matter how big or small your company seems to be.

• Explain the advantages and disadvantages of debt financing and why an organization would choose to issue stocks rather than bonds to generate funds.

If you run into the problem of the current ratio showing that you have the inability to cover the costs of the business then, debt financing may be the best solution for this problem. As we know with all financial options, there are some advantages and disadvantages of any company or business.

The first advantage for debt financing is that it allows the menders or the owners of the company to maintain control and ownership of the company. A second advantage would be that the interest paid on the loan may be tax deductible depending on the type of loan. The best part is the lenders you borrow money from do not share in your profits. The main disadvantage is the risk of credit ratings getting ruined or filing for bankruptcy. As an organization; they can choose to either issue stocks or bonds to help generate funds for the company. Most of the time they prefer to issue stocks over bonds.

Stocks are a form of winnowers; they represent participation in a company's growth (Investigated). A between investors and institutions that, in return for financing, will pay a premium for borrowing, known as a coupon (Investigated). When it comes to the obligation of repay the principle on the stocks you have none; now for the bond you must pay it on the date of maturity. The inertest of the bond has dividends, but the company only pays the dividends when the company makes a profit. The stocks have a fixed interest rate that has to be paid at a specific time.

Discuss how financial returns are related to risk

We know that how the returns work is the greater the risk the greater the returns. The more you invest the more you will get back in returns. The relationship between financial risk and return is the gain or the lost from investments or securities. Just because you have chosen to take a higher risk does not mean that your return will be as high as the risk you took. There are five factors of model investment risk shows risks in terms of credit risk, term risk, market risk, size risk, and price risk. The return on an investment can be measured by a real rate which is what is earned after inflation has been figured into the value. The market, size, and price factors are the link between risk and return. Now the beta stock is one factor that will help to determine the risk.

• Describe the concept of beta and how it is used.

A stocks beta is the measure of an asset's systematic risk and the relative risk (Melcher and Norton). Beta also measures the volatility or variability of an asset's returns relative to the market portfolio (Melcher and Norton). The assets of the company are more volatile than the market. If the company has a greater systematic sis than the market then the betas are greater than 1. . Even though the total risk and the sum of systematic risks are all measured by beta, they are equal and they are all measured in different units. Total risk is measured in percentages and beta is unit less. The rules of how the beta works can be very easy to understand. The beta value will always be greater than 1 if a stocks price moves more than the stock market. If the value of the beta is less than 1, the stock market is moving more than the stocks price. Increased volatility of stock price equals higher risk for the investors ND a higher expected return, therefore betas over 1 are riskier. Betas under 1 are the exact opposite. These stocks have fewer risks, less volatility, and smaller overall returns.

Contrast systematic and unsystematic risk

As mentioned in the above paragraphs, ownership of stock does not come without risks. The types of risks are categorized as systematic and unsystematic risks. The risks are very similar to each other; in that they are both affected by news and represent changes in a stocks return. The combination of these two risk types is noninsured the total risk. At this point is where the similarities between the two risks end.

Systematic risks, also known as non-diversified risks, are common risks that affect all stock. This risk is the portion of an asset that can be linked to market factors that influence all firms (Marina, 2010). The market for the systematic risk is the news, such as hurricanes, war, or an increase in interest rates, that links with the investments of the company. When things like this happen the investors do not have control; and now this presents a higher risk for the stockholders. Now that the hysteretic risks cannot be mitigated through diversification, they require a risk reward for buying a risky stock.

The risky premium is determined solely by the systematic risks of a security. In addition to the risk premium, stockholders expect high returns because of the high risks posed by systematic risks. Unsystematic risks or diversified risks are independent risks that only affect a single company or industry. The risk indicates a portion of an asset that is related to random causes that are linked to firm-specific events. The types of unsystematic events are to be made by the company or the industry specific news.

When a merger happens between two companies this is what falls into the unsystematic risk category. Also other industry factors and events such as labor unions, strikes, lawsuits, and marketing strategies are a unsystematic risk. The changes that happen resulting from the independent risks are unrelated across investments. If the company has one unsystematic event that may happen, this will not have an effect on the entire outcome of the portfolio. Since the risk was so low this meaner that the stock will not be able to receive a risk premium. They can, however, diversify their portfolio to eliminate unsystematic risks. The elimination of the risks lowers the return an investor can expect.

• Imagine your manufacturing corporation has Just won a patent lawsuit.

After attorney and other fees, your corporation will have about $1 million. Explain how you plan to invest the money in order to diversify the risk and receive a good return. Support your decisions with concepts learned in this course. If my manufacturing corporation has Just won a patent lawsuit, I would have to take advantage the financial concepts that I have learned in this class such as financial management, stock and bonds, and the financial risk.

I would use these concepts in order to diversify the risk and receive a good return. I am not for sure as to how much was awarded before the attorney and other fees but, only about $1 million will remain. This money will be invested into different portfolios that would help to diversify the risks that I will be taken not that I have money to do that with. Taking about half of the money to invest in multiple companies that have the potential to row and I can see where it would grow. I would buy shares; this will give me the long term investments.

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