Exploring Key Concepts In Corporate Finance: Gearing, Risk Management, Capital Structure, And Stock Market Efficiency

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Exploring Key Concepts in Corporate Finance: Gearing, Risk Management,Capital Structure, and Stock Market EfficiencyQUESTIONS AND ANSWERSCompanies should gear as much as possible in order to benefit from the advantages ofcheaper debt therebymaximizing shareholders wealth. DiscussGearing is referred to as the increasing the debt content in the organization. The capital structurein any organization has two most prominent resources for financing the needs. One is the sharecapital that belongs to the shareholders that can be either equity or preference shareholder. Theother method is the debt that is the borrowed amount from the creditors.The basic difference inthese two methods of financing is that the shareholders become the owners of the organizationand the amount contributed by them is not necessary to be returned and the dividend is notnecessarily to be paid. Compared to this the creditors are the lenders and they have to be paid inany case and the yearly interest paid to them is also compulsory, though it can be expensed fromthe P&L(Harris, M., & Raviv, A. 2012).There has to a right mix of the equity and the capital in any organization. For some it is regardedthat the debt can be two times of the equity, but any more than that shall cause seriousconstraints for the success of the organization in will be a bottleneck in the day to day working.The reasons for this are very obvious,as debt cause financial constraint in the growth of theprofits. Every loan comes with the rate of interest and that has to be serviced at regular intervalsand the principal repaymenthas to be also undertaken. If the amount so borrowed is not put themost efficient purpose and is unable to give returns equal and more than the interest than the debtservicing will become impossible and the debt service coverage ratio and the interest coverage

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ratio will also not give a positive image of the company. Thus the debt should be in rightproportion to the equity and should not be too high as it has its severe financial implications.Risk management is essential for the success of any company. DiscussEvery organization operates in a very competitive environment and with the advent ofglobalization the opening of the trading windows the challenges have increased a lot. There arenumerousrisks that an organization is exposed to at any point of time and these risks have to bemanaged in a way that the affect of them is mitigated. The major risks that and organizationfaces are:-Internal risksExternal RisksThe internal risk is the risk from the workers of any strike, form the decision makers for thatthere any decision can go wrong, risk against any loss to the raw materials or infrastructure orfraud. The external risks are the risks from the society, form the government policies, from thetrade and exchange policies and the exchange rate.There are many such risks have to be kept inmind and controlled. The best method to do so is to assign the responsibility of risk managementto a group which can look after these challenges and work within the framework of theorganization to analyze the potential intensity of every risk and inform the management in caseof an emergency and suggest the possible path of actions(Stulz, R. M. 2005).These risks are to be managed for the reason that any of the incident that happens due to theserisks cause serious affect in the reputation and the morale of the employees and over and abovethat they have their own financial implications and it takes quite a lot of efforts and the money to

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recover from the untoward incident.Meanwhile the regular activities of the organization are alsohampered and thus these risks are essentially to be enumerated and reviewed at regular intervalsso that the possible threats can be identified and resolved at the earliest.In a recent company board meeting in which you attended, you heard a company directorclaim that it was a total waste of time attempting to determine an optimal level of debt inthe company’s capital structure as company value is not influenced by capital structure.Discuss the claim made by the Director given that companies operate in world of taxation.Do you agree with companies’ director?The optimum level of debt is the level where the equity and the debt is in the right proportion asthat there is no bottleneck in the financing activities of the organization and the business is alsoable to generate the best return for the organization. The optimum level of debt holdssignificance in the capital structure as it will determine the value of the company. Since if thereis nota proper mix and the debt higher than the required limit than it will pose additional dangerfor the organization to generate high returns so as to service the debt and the interest portion. Onthe contrary, if the equity component is high than the required limit than the management of theorganization will be either too much concentrated or segregated and thus the key decisions willbe difficult to happen(Modigliani, F., & Sutch, R.1967).In deriving the value of the company the profit loss of the company plays a major role. Theinterest portion of the debt though high is deductible from the profit and thus reduces the taxburden, contrary to this the dividend is not tax deductible but the expenses in the issue of the

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equity capital can be capitalized and amortized over a period of time and thus they also go on toreduce the profit and lower the tax burden.Thus it is not agreeable to say that the determining theoptimum level of debt in the capitalstructure of the company does not affect the value of the organization.In order for a stockmarket to fulfill its role as an efficient allocator of resources it isessential that it is efficient. DiscussA stock market has to performvarious functions so that there can be fair dealing in the stockmarket while trading for the shares and stocks of the companies. To ensure that the resources areallocated efficiently the stock market shall do the following-1.The daily determination of the sensex value is a pretty sensitive issue as it done on thebasis of the price of certain stocks. Greatest amount of efficiency should be maintained sothat the methodology of determining this value should not known to any outsider as thismay cause serious effects on the trading habit of people.2.The trading is done by many small investors who have little knowledge about themovement of the market. The stock exchange should effectively regulate the way ofdealing so that the interest of the small investors can be safeguarded against the largeinvestors who actually guide the market.3.Stock market should also regulate thelevy of the tax on the trading for both the inter dayandintradayso that they should not discourage the investors from entering the market.This will also act as a motivation for the inventors for trading in large quantities.

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4.Stock market can also regulate the listing and the de listing procedure to be followed sothat more companies can feel the ease of getting listed on stock exchange and make thedisclosures to public(Diamond, P. A.1967).There are various ways in which investors looking to invest in the stock markets selectsecurities with the goal of trying to outperform the market. Discuss theThere are many investors in the market and the basic aim they carry is to maximize the returnfrom the investments so that they can earn the returns more than what is available in the risk freesecurities. While selecting the securities from the market the investor adopts various ways. Themajor types ofthem are-The investor may like to have all the securities that have the beta more than 1. This means thatthe securities have a high risk and are very volatile and the returns may be good. This kind ofinvestor may like to invest for a short period or long period. But to gain the advantage of thevolatility the investor may invest for short period(Barro, R. J.1990).The second kind of method may be the one where the investor may have the securities that mayhave the beta 1 and they will be not very risky or very lucrative. The investor may want to beinvested for long period so that he can have returns more than the risk free securities and alsotake the advantage of the tax exemption on the long term capital gain.The other method may be like having some security with more than 1 beta and the other with lessthan 1 beta so that the fluctuations and the risk of the one can be set off by another. Such kind of

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