Assignment 2 Fin MNGT Complete

Financial Management 2
FIM2246/2020/2/A1
Assignment 1
Student Name: RK Pauchcowrie

Student No: 156859
Question One
RK Pauchcowrie 156859 7805050240089

Ten Strategies used by Finance Managers
1) Reduce supplier credit costs.

2) Take advantage of supplier discounts
3) Renegotiating with suppliers for preferential pricing
4) Improve on debt collection
5) Reduce debt
6) Eliminate early payment discounts to customers
7) Invest in technology
8) Invest in quality human capital
9) Implement strategic plans
10) Proper credit screening of customers
Question 2
Differentiate between money and capital markets.
Money can be described as an asset and a generally acceptable means of payment in the
sale and purchase of goods and services. Money can also be held for a period of time and be
used to finance future payments (store of value), can be used as a common medium of
exchange, can be used to measure and record the value of products and assets (unit of
account). The money market is a component of the financial market for assets involved in
short term borrowing, lending, buying and selling within a year or less. Trading is done over
the counter and is wholesale. Money market instruments include collateral loans, deposits,
certificate of deposits, bills of exchange, repurchase agreements.
The Capital market encompasses both the trade in stocks and bonds. They are longer-term
assets bought by financial institutions, professional brokers and individual investors, as
opposed to money markets which is a trade in short term debt. Where the money market is
a short-term lender solution, the capital market is geared towards long term investing.
Companies issue stocks to raise money to raise funds to grow their business and investors
buy these shares to be a part of the growth.
While the money market is less risky the capital market is potentially more rewarding.
Question 3
RK Pauchcowrie 156859 7805050240089

Examine common stock as a major source of capital
Common stock represents shares entitling their holder to dividends depending on the
profit / loss of the Company. There are numerous ways to raise capital for your business.
One of the most popular is issuing of ordinary shares (common stock) to investors willing to
part with their funds in exchange for shares in your Company.
Some advantages include:
 Voting Rights – Common shareholders can participate in internal corporate

governance through voting. Shareholders have a certain amount of say in how the
business is run and can participate in important decision making. Each common
share equals one vote.
 Gains – A straight forward way for investors to benefit and generate income,
although profits are not guaranteed. Shares can also be sold at a higher price than it
was purchased. Shareholders can reinvest profits or receive them as income.
 Limited Liability – Common shareholders are protected against the financial
obligations of the Company and are only liable for their share’s value. Common
shareholders also gain access to new share issues before the public.
Disadvantages:
 Common shareholders are the last to be paid. If the Company liquidates you are
most likely to lose your investment. Preferred shareholders get paid before ordinary
shareholders and if there in nothing left common shareholders do not get paid.
 It is difficult to exercise control over your investment. You have limited or no control
over decisions taken. You are subject to the will of the majority stockholders.
 It is a risky investment as there can be no dividends paid depending on the
Companies profit / loss.
Question 4
4.1 Give reasons why cash management is important to any business?
Cash Management refers to the collection, concentration and disbursement of cash. It
includes the Company’s liquidity, its management of cash and its short-term investment
strategies.
It is important for new and growing businesses, as cash flow can be problematic even if a
small business has numerous clients, offers a superior product or has a good reputation
within the industry.
Companies that have cash flow problems have no margin of safety in case of unexpected
expenses. They may also have problems securing funding for innovation or expansion.
RK Pauchcowrie 156859 7805050240089

Poor cash flow makes is difficult to hire and retain good employees as payment of wages
and salaries are affected when cash flow is poorly managed.
Cash is the lifeblood of a store. Without cash available for salaries, stock, expenses etc a
crisis is imminent.
4.2 Outline the Beta Coefficient of a firm and outline the determinants of Beta
In finance the Beta of a stock or portfolio is a number describing the relationship of its
returns with that of the financial market as a whole.
The Beta Coefficient is a key parameter in the capital asset pricing model (CAPM). It
measures the part of the asset’s statistical variance that cannot be mitigated by the
diversification provided by the portfolio of many risky assets, because of the correlation of
its returns with the returns of the other assets that are in the portfolio.
The variance and covariance (Beta), depend on 3 fundamental factors:
1) The nature of the business – All economies experience business cycles. The earnings
of some companies fluctuate more and their earnings grow during the growth phase
and decline during the contraction phase. The implication is that if a firm’s earnings
are more sensitive to business conditions, they have a high Beta, however, a
Company’s earnings may be highly variable but it may not have a high Beta
2) Operating Leverage – Refers to the use of fixed costs. The degree of operating
leverage is defined as the change in an economy’s earnings before interest and tax
due to a change in sales. If all other things remain the same companies with higher
operating leverage are more-risky.
3) Financial Leverage – Refers to debt in a firm’s capital structure. Firms that have debt
in the capital structure is called leverage firms. Since financial leverage increases the
firm’s financial risk, it will increase the equity Beta of that firm.
Question 5
Critically examine the CAPM model clearly outlining what it entails, assumptions &
criticisms
The Capital Asset Pricing Model (CAPM) is a model in finance that is used to price risky
assets. It was developed by William Sharpe in 1968.
For CAPM to hold it uses a set of assumptions:
1) Perfect markets
2) A world of no taxes
3) A world of no transaction costs
RK Pauchcowrie 156859 7805050240089

4) Homogenous expectations by investors
5) Investors are rational and risk averse.
6) There is a risk-free asset that earns a risk-free rate
Using these assumptions, the theory distinguishes between the systematic risk and
unsystematic risk of an asset. CAPM highlights that the unsystematic risk of an asset is
irrelevant in the pricing of risky assets because it can be diversified away through combining
assets which are negatively correlated to each other. It highlights that the only risk that is
relevant in pricing is the systematic risk which is market-wide risk caused by changes in the
macro-economic fundamentals such as interest rates, exchange rates and inflation.
This brings about the Beta of an asset which is a measure of an asset’s systematic risk. The
model thus arrives at the equation for pricing risky assets using the risk-free rate and the
systematic risk of an asset. According to CAPM the return in a risky asset is given by the
following equation:
Ri = Rf = βi(Rm-Rf) where:
RF – is the risk-free rate that investors are given to compensate for the time value of money
Βi – Is the measure of an assets systematic risk
Rm – is the return on the market and hence (Rm-Rf) is the risk premium that investors are
rewarded in the market for investing in risky assets.
The limitations of CAPM that limit its applicability in the real world are that it is based on
unrealistic assumptions.
1) In the real world there is no risk-free asset
2) In the real-world taxes are very relevant and investors are charged transactions costs
3) Not all investors are risk averse and some investors actually pay to be exposed to risk
like gambling
4) All investors do not have homogenous expectations.
CAPM is criticised for its unrealistic assumptions as discussed above. Also, the fact that
CAPM is based on historical data e.g. the beta is calculated using historical data. Also, the
beta of a firm has been found not to be stationary. It changes over time and hence the
expected returns calculated based on CAPM may differ greatly with actual returns.
RK Pauchcowrie 156859 7805050240089

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Financial Management 2

Student Name: RK Pauchcowrie

RK Pauchcowrie 156859 7805050240089

1) Reduce supplier credit costs.

RK Pauchcowrie 156859 7805050240089

 Voting Rights – Common shareholders can participate in internal corporate

RK Pauchcowrie 156859 7805050240089

RK Pauchcowrie 156859 7805050240089

RK Pauchcowrie 156859 7805050240089

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