Risks Associated with Derivatives

Although derivatives are legitimate and valuable tools for hedging risks, like all financial instruments they create risks that must be managed. Warren Buffett, one of the world’s most wise investors, states that “derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” On one hand derivatives neutralize risks while on the other hand they create risks. In fact there are certain risks inherent in derivatives. Derivatives can be dangerous if not managed properly. Numerous financial disasters such as Enron can be related to the mismanagement of derivatives. In the 1990s, Procter & Gamble lost $157 million in a currency speculation involving dollars and German Marks, Gibson Greetings lost $20 million and Long-Term Capital Management, a hedge fund, lost $4 billion with currency and interest-rate derivatives. It is key to consider that it has not been the use of derivatives as a tool which hasContinue reading

Credit Rating

Credit rating is a codified rating assigned to an issue by authorized credit rating agencies. These agencies have been promoted by well-established financial Institutions and reputed banks/finance companies. Credit rating is a relative ranking arrived at by a systematic analysis of the strengths and weaknesses of a company and debt instrument issued by the company, based on financial statements, project analysis, creditworthiness factors and future prospectus of the project and the company appraised at a point of time. Objectives of Credit Rating Credit rating aims to: Provide superior information to the investors at a low cost; Provide a sound basis for proper risk-return structure; Subject borrowers to a healthy discipline, and Assist in the framing of public policy guidelines on institutional investment. Thus, credit rating in financial services represent an exercise in faith building for the development of a healthy financial system. Approaches to Credit Rating As a technique forContinue reading

Role of Financial Statements Analysis in Making Investment Decisions

One of the most important long-term decisions for any business is investment with the aim of making gains in the future. Investment decisions are concerned with the use of funds including buying, holding or selling and each decision could be vital to a firm. A careless decision may result in a long-term loss or even worse, bankruptcy. Therefore, an in-depth understanding and analysis is necessary for a high quality investment decision process. This is also even more critical to investors who invest in stock of company or shareholders. Financial statement analysis is critical in making effective stock investment decisions. By study the balance sheet, income statement, cash flow statement and statement of owners’ equity separately and combined, an analyst might have a good sense of a company’s overall financial picture; therefore, the investment decisions are likely to be reasonable and profitable. Financial Statements Analysis In order to understand the analysisContinue reading

Financial Management Decisions

Financial Management is concerned with the acquisition and utilization of capital funds in meeting the financial needs and overall objectives of a business enterprise. Thus the primary function of finance is to acquire capital funds and put them for proper utilization, with which the firm’s objectives are fulfilled. The firm should be able to procure sufficient funds on reasonable terms and conditions and should exercise proper control in applying them in order to earn a good rate of return, which in turn allows the firm to reward the sources of funds reasonably, and leaves the firm with good surplus to grow further. These activities viz. financing, investing and dividend payment are not sequential they are performed simultaneously and continuously. Financial Management Decisions – Three Major Decisions in Financial Management The Financial Management can be broken down in to three major decisions or functions of finance. They are: (i) the investmentContinue reading

Areas and Scope of Financial Management

Financial management, at present is not confined to raising and allocating funds. The study of financial institutions like stock exchange, capital, market, etc. is also emphasized because they influenced under writing of securities & corporate promotion. Company finance was considered to be the major domain of financial management. The scope of this subject has widened to cover capital structure, dividend policies, profit planning and control, depreciation policies. Some of the functional areas covered in financial management are discussed as such- Determining financial needs:- A finance manager is supposed to meet financial needs of the enterprise. For this purpose, he should determine financial needs of the concern. Funds are needed to meet promotional expenses, fixed and working capital needs. The requirement of fixed assets is related to types of industry. A manufacturing concern will require more investments in fixed assets than a trading concern. The working capital needs depend upon scaleContinue reading

Qualitative Characteristics of Financial Information

Qualitative characteristics are the attributes that make financial information useful to users. The qualitative characteristics of financial information can be categorized as fundamental (relevance and faithful representation) or enhancing (comparability, verifiability, timeliness and understandability) based on how they influence the usefulness of financial information. Fundamental Qualitative Characteristics of Financial Information 1. Relevance Relevant financial reporting information means the ability of users (shareholder) to make a difference in their decision. Information regarding to economic phenomenon will help the users make a difference decision if it included predictive value and confirmatory value. Predictive Value: Information has predictive value if the value can be useful to the shareholder in predicting certain things that is related to future. Information which is highly predictable does not necessary has predictive value. For instance, depreciation of plant and equipment by using straight line method can be highly predictable every year, but it cannot assist in evaluating theContinue reading