Definition of Financial Terms

Business Studies Essay on Money and Banking

Money and Banking

Question 1

Glass co. has a credit rating of AAA which shows that it is rated vastly credit wise as well as has a low chance of evading its credit responsibilities. Aluminum Co. has a credit rating of BB- which is fairly low as well as shows a higher chance of evading its monetary duties. This in itself ought to fret a financier due to the fact that there is no promise of dividend being paid. The share rate of Glass Co. is twice as high as that of Aluminum Co. however it produces dividends twice those of Glass Co. This shows that even though a shareholder may be capable to purchase more shares of Glass Co. of Aluminum Co., the profits will be the same. There is a huge danger in putting money in Glass Co. than Aluminum Co and so I would advise Sam to put money on Aluminum Co.

Credit ratings

Color codeNumberDefinitionMoodysS & PFitch
Investment Grade  
10Prime, maximum safetyAaaAAAAAA
9.5Very high grade/qualityAa1AA+AA+
9Aa2AAAA
8.5Aa1AA-AA-
8Upper medium qualityA1A+A+
7.5A2AA
7A3A-A-
6.5Lower medium gradeBaa1BBB+BBB+
6Baa2BBBBBB
5.5Baa3BBB-BBB-
Color codeNumberDefinitionMoodysS & PFitch
Speculative grade
5SpeculativeBa1BB+BB+
4.5Ba2BBBB
4Ba3BB-BB-
3.5Highly speculativeB1B+B+
3B2BB
2.5B3B-B-
2Substantial riskCaa1CCC+CCC+
1.5In poor standingCaa2CCCCCC
1Caa3CCC-CCC-
0.5Extremely speculativeCaCCCC
0Maybe in or extremely close to defaultCC+,C,C-C+,C,C-
0DefaultDD

 

Question 2

Financial investments need agents to fulfill the deal. Agents are authorized to undertake this job and make their earnings from negotiating payment that they charge (Sanderson 1992). This is the initial price that any monetary deal experiences. There is the spread price which is the variation between the amount the broker paid for the stock and the rate the buyer pays. Brokerage costs as well as spread fee can be lessened by buying securities on one occasion. This will reduce the amount of money that may be lost via spread fee. Citing the least cost for the security being bought will as well lessen the total spread fees.

Question 3

Real interest rate is nominal interest rate- inflation rate

Inflation rate 1%

Government bond= 3%-1%=2%

Commercial bonds = 7% – 1% =6%

CBAF Fin. Inv. Inc. = 10% – 1% = 9%

Founded on the recent inflation rate of 1 percent none of the investments can be labelled as loss. Altogether, they are going to get a positive increase to the financier’s buying power after the variations in costs are represented (Neely and Rapach 2008).

Graph showing the relationship between real and nominal rates

Question 4

Risk premium is the sum of money paid in surplus of the threat free gain that an investment is anticipated to produce. It works as a kind of remuneration to financiers to withstand the dangers of their investment. An investment with an extremely low threat has a low risk premium (Lally 2010). This is due to the fact that the financier has a little opening of losing the investment made. Investments that carry vast dangers for example on business bonds from small corporations have a huge risk premium as the investments are vastly dangerous. Sam ought to look at risk premium when placing his money on commercial bond soared by Giants Corp. this is due to the fact that the credit rating of the corporation is extremely low which makes the investment a high threat. This is vastly perilous even though it has a fairly high profit rate Sam ought to look at the risk premium if he opts to place some amount on it.

Question 5

There are hazards that are likely to accompany investments. However, Sam does not actually need to alert the bank on his investment as when he borrowed the money the repayment was not attached on his heritage. This shows that he was assumed to clear the loan using revenue from his work. He does not plan to stop working which shows that even though his investment makes losses he will have wages to service the loan. Given that he is paying his monthly repayments as settled the bank has no desire for data concerning his inheritance not unless he hopes to change his payment plan.

Question 6

Sam has ample sum of money to culminate his loan and yet invest. Nevertheless, he has the choice of keeping the repayments as well as paying the loan in remaining 20 years. This would be the best decision if he opts to make an investment with a huge profit than the interest rate of the loan. If he invests in CBAF Fin. Inv. Inc., he will get an interest rate of 10 percent per year. This will be double the sum of interest he is clearing on his loan. He can as a result pay the loan using the interest from the investment. This shows that the amount he requires to get rid of the loan will produce much more if he invests it. It will have provided him an equal or quarter of the money he is obliged by the bank. He will get 10 percent from the investment as well as pay an interest rate of 5 percent. This indicates that if we calculate the inflation rate of the 20 years period he will make at least 3 percent interest from the amount he could have utilized to clear the loan in large amount (Fairfield 1994). As a result it makes more monetary logic to capitalize the money instead of clearing the loan because of the merits coming from the interest the investment will fetch.

Question 7

100, 000 dollars per year for 3 years = 300, 000.

Pv= future cash flow/ (1+ interest rate) number of years

300,000/ (1+7%) 3=244,889.36

The value gained shows that the real amount of money made by the investment will be less than the value gained. This is due to the cost of living will be huge making the value of dollar these days vast than in three years to come.

Question 8

Monetary policy is the procedure that the financial power of a nation utilizes regulate the supply of money. This is achieved by using the interest amounts charged by commercial banks on loan (Zoli 2006). This is undertaken to regulate facets of economy for instance lack of jobs and prices. This is meant to regulate, the sum in flow. The moment the banks charge low interest rate most individuals are able to lend which surges the sum of money in flow. When the state need to lessen the sum of money in flow it surges the interest rates which in turn lessens the sum of loans individuals are taking fruitful lessening the sum of money in flow. Monetary policies are the regulation of the economy by the state via income collection as well as spending. This is undertaken to regulate the economy by finding out how the state spends in diverse sectors. The amount of earnings the state gathered defines how it is capable of dealing with its monetary responsibilities. When the state has large debts it surges its income gathering to clear its bills as well as its debts and when it has more revenue than its debts as well as spending it lessens the sum of tax it collates. This is all that monetary policy does, regulate the sum of money state has by controlling the amount of taxes it gathers founded on its spending (Bunea-Bontas and Petre 2010).

 

References

Bunea-Bontas, C. & Petre, M.C. 2010, “FISCAL POLICY DURING THE CURRENT CRISIS”, Romanian Economic and Business Review, vol. 5, no. 4, pp. 48-67.

Fairfield, P.M. 1994, “P/E, P/B and the present value of future dividends”, Financial Analysts Journal, vol. 50, no. 4, pp. 23.

Lally, M. 2010, Estimating the Market Risk Premium Using Historical Data from Multiple Markets, Rochester.

Neely, C.J. & Rapach, D.E. 2008, “Real Interest Rate Persistence: Evidence and Implications”, Review – Federal Reserve Bank of St.Louis, vol. 90, no. 6, pp. 609-641.

Sanderson, S. 1992, “The Financial Impact of Risk Costs”, Risk Management, vol. 39, no. 8, pp. 46.

Zoli, E. 2006, How does Fiscal Policy Affect Monetary Policy in Emerging Market Countries?, Rochester.

 

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