Financial Markets Case Study

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1. (i) Explain the functions of financial markets. Answer: Financial markets have the following 4 functions in general. Capital accumulation The financial market plays a role like “reservoir” to lead a large number of scattered small sums of money in a form of cash to places where it is really needed. It can be done because financial markets have created the liquidity of financial assets and also the diversification of financing tools provided the appropriate means for capital providers to find a way out for the investment funds. Resources allocation The allocation of resources - Economic resources of a society can be used more effectively as funds are always flowing to sectors and businesses that have the greatest potential for development.…show more content…
Monetary policy is an important economic policy of regulating the economic activities of the macroeconomic concept. Reflect the economy The financial market has always been known as the "barometer" and "weather station" of the national economy, which is recognized as the national economic signal system. This is actually a reflection of the function of financial markets. 1. (ii) Discuss why a dollar tomorrow cannot be worth less than a dollar the day after tomorrow. Answer: Money can be invested to gain return or interest over a period of time as it has a time value. But money in future can’t be invested immediately to earn interest and so must be worth less. For example, if an amount of $10,000 deposit to a saving account at an annual interest rate of 5% and compounded monthly, the amount can get after 10 years will be $16,470.09. But you can’t get $10,000 future dollar by today for investment. Based on the following formula and example, $10,000 principle (Present value) after a specific time (10 years) has the value of $16,470.09 (Future value), which $10,000 is the original principle and $6,470.09 is the interest that earned after 10 years. This is the time value for money…show more content…
This can be achieved by exploiting a higher cost of capital in an investment decision or by setting a capital budget limit. Corporation would like to implement it in situations that the returns of past investments were lower than expected. The main advantage of capital rationing is the efficient use of the company’s corporate resources by enforcing strict budgeting of company’s corporate resources to focus on the higher return projects or investments. In addition, it prevents the wastage of corporate resources by investing on the unavailable or lower returns projects. Also, imposing capital budgets lead the company to focus on the less number of comparatively higher return projects and so number of active projects can be kept in minimal and projects or investments can be managed better. There are two main types of capital rationing, hard rationing and soft rationing. Soft capital rationing is used when the limitations are imposed from company inside. For example, management would like to concentrate on the main business or some focused projects, limited skilled management to handle many projects at the same time, or management doesn’t want to do external

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