Financial Management and Markets

Financial Management and Markets

Respond to the following questions using grammatically correct language.

1. Martha Stewart was accused of insider trading for selling ImClone stocks a day before the stock went down in value. The charges of securities fraud were thrown out, but she served five months in prison for obstruction of justice and lying to investigators. Do you think what Martha did (insider trading) was unethical from a financial management point of view? Explain.

The extent to which it can be agreed that Martha Stewart acted unethically from a financial viewpoint is arguable. Notably, this is so because selling stocks is not unethical in any form. However, selling the stocks just a day before their values went down is questionable, as it is unclear whether she had insider information regarding the fall in price of the stocks. According to Liu et al. (2020), insider trading is not only unethical but also illegal, which could imply that Martha committed a crime. Noting that the court vindicated her as no evidence for insider trading was available, I think Martha’s actions were ethical from a financial point of view. Further, lying to investigators and obstructing evidence was unethical.

2. Explain why wealth maximization is more desirable than profit maximization as a goal for any company.

In their quest for financial success, businesses seek two distinct goals: wealth maximization and profit maximization. While profit maximizing focuses primarily on growing short-term earnings, wealth maximization considers long-term value creation for shareholders, which is a broader and more sustainable approach. Wealth maximization stresses the entire increase in the net worth of the company, which includes not only immediate earnings but also the time value of money and risk. One significant advantage of wealth maximization over profit maximization is its capacity to account for a company’s long-term viability. Profit maximization may drive businesses to emphasize short-term advantages above long-term stability and growth.

Wealth maximization, on the other hand, evaluates the long-term impact of financial actions, encouraging businesses to make decisions that would increase shareholder value over time. This strategy is more in line with the interests of shareholders who want not only immediate rewards but also the certainty of a stable and increasing investment. Furthermore, wealth maximization provides a more complete picture of a company’s financial performance. Wealth maximization covers a broader range of financial indicators than profit maximization alone because it focuses on cash flows, asset appreciation, and risk management. This comprehensive methodology better captures a company’s genuine economic value, indicating not only its profitability but also its ability to generate long-term growth and shareholder wealth. Conclusively, while profit maximization focuses on short-term profits, wealth maximization provides a more solid foundation for long-term success by taking into account long-term financial health and shareholder value generation.

3. Classify the following transactions as taking place in the primary or secondary markets by placing an “X” in the appropriate cells for questions 3 and 4.

Markets

4. Classify the following financial instruments as money market securities or capital market securities:

Financial Instruments

5. Explain the shape of the yield curve with respect to the unbiased expectations and liquidity premium

There will be a downward-slopping yield curve if it is predicted that future rates will fall. The curve will slope upwards if one-year future rates are predicted to rise and flat if future rates are forecast to stay level under UET. According to Bluwstein et al. (2023), long-term rates under LPT are equivalent to the mean of present and anticipated short-term rates, added to premiums for liquidity risk that rise with the maturity of the instrument. In fact, a yield curve sloping upwards may represent anticipations that there will be a rise in future interest rates, remain unchanged, or even decline, according to Bluwstein et al. (2023), if there is a quickly enough rise in liquidity premium with maturity to create an upward-sloping yield curve. Stated differently, the curve is determined by investors’ inclination to wager on longer-term yields that carry greater risk rather than interest rates.

6. Imagine a particular security’s default risk premium is 2 percent. For all securities, the inflation risk premium is 1.75 percent and the real risk-free rate is 3.50 percent. The security’s liquidity risk premium is 0.25 percent, and the maturity risk premium is 0.85 percent. The security has no special covenants. Calculate the security’s equilibrium rate of return. Show your work.

2% + 1.75% + 3.5% + .25% + .85% = 8.35% Equilibrium Rate of Return

 References

Bluwstein, K., Buckmann, M., Joseph, A., Kapadia, S., & Şimşek, Ö. (2023). Credit growth, the yield curve and financial crisis prediction: Evidence from a machine learning approach. Journal of International Economics, 103773.

Liu, R., Mai, F., Shan, Z., & Wu, Y. (2020). Predicting shareholder litigation on insider trading from the financial text: An interpretable deep learning approach. Information & Management, 57(8), 103387.

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In this assessment, you will explore various aspects of the business environment, including the role of financial managers. Financial managers are known as the agents of company owners (stockholders) who are tasked with achieving the goal of maximizing shareholder wealth using tools of financial markets. You also receive an introduction to the various types of financial markets and the relationships between interest rates and other economic variables.

Financial Management and Markets

The following resources introduce the aspects of financial management, markets, and institutions, including financial instruments, the role of the SEC, rules and regulations governing financial markets, and macro-economic variables relevant to financial markets.

Principles of Finance:
Chapter 1, “Introduction to Finance.”
This chapter describes the main areas in finance. It also explains the importance of studying finance and discusses the concepts of risk and return.
The Role of the Chief Financial Officer.
Details the duties and responsibilities of the CFO.
Financial Markets.
Provides an introduction to financial markets—what they are and how they operate.