Where does the financing for corporations come from?The ultimate source of financing is individuals’ savings.The savings flow through financial markets and intermediaries.The intermediaries include mutual funds,pension funds, and financial institutions, such as banksand insurance companies.
What if a corporation finances investment by retainingand reinvesting cash generated from its operations?In that case the corporation is saving on behalf of itsshareholders. Although shareholders will receive smallerdividends now, reinvestment of their funds may help generatemore wealth and provide higher future returns.
What are the key advantages of mutual funds andpension funds?Mutual and pension funds allow investors to diversify inprofessionally managed portfolios. Pension funds offer anadditional tax advantage, because the returns on pensioninvestments are not taxed until withdrawn from the plan.
What are the functions of financial markets?Financial markets help channel savings to corporateinvestment, and they help match up borrowers andlenders. They provide liquidity and diversification opportunitiesfor investors. Trading in financial marketsprovides a wealth of useful information for the financialmanager.
Do financial institutions have different functions?Financial institutions carry out a number of similarfunctions but in different ways. They channel savings tocorporate investment, and they serve as intermediariesbetween borrowers and lenders. Banks also provide liquidityfor depositors and, of course, play a special role inthe economy’s payments systems. Insurance companiesallow policyholders to pool risks.
How does the financial manager identify the cost ofthe capital raised by a corporation?The cost of capital is the minimum acceptable rate ofreturn on capital investment. It’s an opportunity cost, thatis, a rate of return that investors could earn in financialmarkets. For a safe capital investment, the opportunitycost is the interest rate on safe debt securities, such ashigh-grade corporate bonds. For riskier capital investments,the opportunity cost is the expected rate of returnon risky securities, investments in the stock market, forexample.
