Financial Management

Environment

12/04/22 Wachawaseme Mwale 1

 Economic policies of Government
• Microeconomics is concerned with economic
behaviour of individual firms and consumers
or houseshold.
• Macroeconomics is concerned with the
economy at large and with the behaviour of
large aggregates such as the national income,
the money supply and level of employment.

12/04/22 Wachawaseme Mwale 2

 Economic policies and objectives
These are:
•Economic growth- increases in national income
in real terms.
•Control price inflation.
•Full employment
•Balance of payments stability i.e. export must
exceed imports and not the other way round.

12/04/22 Wachawaseme Mwale 3

 Policies used
• Monetary policy. i.e. rate of interest, money
supply
• Fiscal policy. That is government spending
and Taxation
• Exchange rate policy. Will influence imports
and export.
• External trade policy.

12/04/22 Wachawaseme Mwale 4

 Fiscal policy
• This is policy to spend money, collect money with
the aim to influence the condition of the national
economy.
• The following would be the intervention the govt
could do.
– Spending more money
– Collecting more taxes without increase in public
spending
– Collecting more taxes in order to increase public
spending.

12/04/22 Wachawaseme Mwale 5

 Results of fiscal policies
• Enhanced demand of goods if governments
spends more
• Reduced taxes also increases demand of
goods.
• Increases in taxes reduce demand of goods

12/04/22 Wachawaseme Mwale 6

 Monetary policy
• This is control of monetary systems such as
money supply, interest rates and conditions
for the availability of credit.
• Money supply as target of monetary policy.-
increase in money supply will raise the prices
of goods.
• Interest rates as target of money policy.-
increase in interest rates will reduce the
money supply.

12/04/22 Wachawaseme Mwale 7

 Exchange rates
• These are determined by supply and demand.
• Supply and demand are further influenced by
the following factors.
– The rate of inflation
– Interest rates
– The balance of payments
– Speculations
– Government policy to intervene. E.g. in 2012

12/04/22 Wachawaseme Mwale 8

Consequences of an exchange rate
• Reasons for policy to control exchange rates.
– To rectify a balance of trade deficit,
– To prevent balance of trade surplus.
– To stabilise the exchange rates.
• There are two types of exchange rates policy
– Fixed exchange rates
– Floating exchange rates.

12/04/22 Wachawaseme Mwale 9

 Financial markets
• Are markets where individuals and
organisations with surplus funds lend funds to
other individuals and organisations.
• Classifications:
– Capital and money market
– Primary and secondary market
– Exchange traded and over the counter markets.

12/04/22 Wachawaseme Mwale 10

 Capital markets and money markets
• Money markets are markets for:
– Trading short term financial instruments
– Short term borrowing and lending
• Money markets are operated by banks and
other financial institutions.
• Capital markets
– Are markets for trading long term finances. E.g.
long term financial instruments (equity and
bonds)
12/04/22 Wachawaseme Mwale 11
 Primary and secondary markets
• Primary market enable organisations to raise
new finances by issuing shares or bonds
• Secondary markets enable investors to buy or
sale existing investments.

12/04/22 Wachawaseme Mwale 12

Exchange traded and over the counter
• Secondary market for financial securities can
be sold at the organized exchanges.
• Alternatively, secondary market can be
operated as over the counter markets where
customers can negotiate individual
transaction.
• Over the counter securities can be:
– Negotiable. Can be resold
– Non negotiable. Can not be resold

12/04/22 Wachawaseme Mwale 13

 Financial Intermediaries
• A financial intermediary links those with
surplus funds (eg lenders) to those with fund
deficits (eg potential borrowers).
• A financial intermediary links lenders with
borrowers, by obtaining deposits from lenders
and then relending them to borrowers

12/04/22 Wachawaseme Mwale 14

 Financial Intermediaries Cont’d
• Examples of financial intermediaries
– Commercial banks
– Finance houses
– Mutual societies
– Institutional investors eg pension funds and
investment funds

12/04/22 Wachawaseme Mwale 15

 Financial Intermediaries Cont’d
• Benefits of financial intermediaries
– They provide obvious and convenient ways in
which a lender can save money
– Financial intermediaries also provide a ready
source of funds for borrowers
– They can aggregate smaller savings deposited by
savers and lend on to borrowers in larger
amounts.
– Risk for individual lenders is reduced by pooling.

12/04/22 Wachawaseme Mwale 16

Functions of financial Intermediaries
Go-between
•Firms with economically desirable projects might want funds to
finance these projects, but might not know where to go to find
willing lenders.
•Similarly, savers might have funds that they would be willing to
invest for a suitable return, but might not know where to find
firms which want to borrow and would offer such a return.
•Financial intermediaries are an obvious place to go to, when a
saver has funds to save or lend, and a borrower wants to obtain
more funds.
•They act in the role of go-between, and in doing so, save time,
effort and transaction costs for savers and borrowers.

12/04/22 Wachawaseme Mwale 17

Functions of financial Intermediaries
Maturity transformation
•Lenders tend to want to be able to realise their investment and
get their money back at fairly short notice. Borrowers, on the
other hand, tend to want loans for fixed terms with predictable
repayment schedules.
•Financial intermediaries provide maturity transformation,
because savers are able to lend their money with the option to
withdraw at short notice, and yet borrowers are able to raise
loans for a fixed term and with a predictable repayment
schedule. Financial intermediaries such as banks and building
societies are able to do this because of the volume of business
they carry out.

12/04/22 Wachawaseme Mwale 18

Functions of financial intermediaries
Risk transformation
•When a lender provides funds to a borrower, he must
accept a risk that the borrower will be unable to repay.
Financial intermediaries provide risk transformation.
•When a saver puts money into a financial
intermediary, his savings are secure provided that the
intermediary is financially sound.
•The financial intermediary is able to bear the risks of
lending because of the wide portfolio of investments it
should have.

12/04/22 Wachawaseme Mwale 19

Functions of financial intermediaries
Aggregation
•Borrowers tend to want larger loans than individual
savers can provide. For example, a firm might want to
borrow $10,000, but the only savers it finds might be
able to lend no more than $1,000 each so that the firm
would have to find ten such savers to obtain the total
loan that it wants.
•Financial intermediaries are able to 'parcel up' small
savings into big loans, so that the discrepancy between
small lenders and large borrowers is removed by the
intermediary.

12/04/22 Wachawaseme Mwale 20

 Securitisation
• This is the process of converting the illiquid
assets into marketable asset-backed
securities.
• These securities are backed by specific assets
and are normally called asset backed security
(ABS).
• The oldest being mortgage backed bonds
security (MBS)

12/04/22 Wachawaseme Mwale 21

 The Efficient market hypothesis
• The efficient markets hypothesis is concerned with the
information processing efficiency of stock markets.
• Different types of efficiency can be distinguished in the
context of the operation of financial markets.
( Allocative, Operational and Information processing
efficiency).
Allocative efficiency
• If financial markets allow funds to be directed towards
firms which make the most productive use of them,
then there is allocative efficiency in these markets.
• This helps maximize economic prosperity.
12/04/22 Wachawaseme Mwale 22
Operational efficiency
– Transaction costs are incurred by participants in
financial markets, for example commissions on
share transactions, margins between interest
rates for lending and for borrowing, and loan
arrangement fees.
– Financial markets have operational efficiency if
transaction costs are kept as low as possible.
Transaction costs are kept low where there is
open competition between brokers and other
market participants.
12/04/22 Wachawaseme Mwale 23
Informational processing efficiency
– The information processing efficiency of a stock
market means the ability of a stock market to
price stocks and shares fairly and quickly. An
efficient market in this sense is one in which the
market prices of all securities reflect all the
available information.

12/04/22 Wachawaseme Mwale 24

• There are three forms of market efficiency.
– Weak form efficiency
– Semi-strong form efficiency
– Strong form efficiency

12/04/22 Wachawaseme Mwale 25

 Weak form
• This implies that prices reflect all the relevant
information about past price movements and
their implications
• It does not react to much of the information
that is available about the company.

12/04/22 Wachawaseme Mwale 26

 Semi strong form efficiency
• Implies that prices reflect past price
movements and publicly available knowledge.
• All publicly available knowledge about the
company and market return.

12/04/22 Wachawaseme Mwale 27

 Strong form efficiency
• Share prices reflect all information, whether it
is publicly available or not.
– From past price changes
– From public knowledge or anticipated.
– From specialists’ experts’ insider knowledge

12/04/22 Wachawaseme Mwale 28

 Impact of efficiency on share price
• If the stock market is efficient, the share
prices should vary in a rational way.
– If a company make an investment with +NPV, the
share price will increase.
– If interest rates rise the shareholders will want a
higher return so market price will fall

12/04/22 Wachawaseme Mwale 29