the creation process for financial assets

how are financial assets created? we may illustrate this process using a rudimentary financial system in which there are only two economic units: a household and a business firm. assume that this financial systems closed, so no external transaction with other units are possible. each unit holds certain assets accumulated over, the years as a result of it's saving out of current income. the household for example, may have accumulated furniture an automobile, clothes and other items needed to provide entertainment food, shelter and transportation. the business firm holds inventories of goods to be sold raw materials machinery and equipment and other assets required to product and sell it to the public. the financial position of these two economic units is presented in the form of balance sheets. a balance sheet of course is a financial statement prepaid as of a certain data, showing a particular units assets liabilities and net worth. net worth represents the accumulated sources of funds that an economic unit drawn upon to acquire the assets it now holds the net worth account reflects total saving accumulated over time by each economic unit. a balance sheet must always balance. total assets must equal total liabilities plus net worth.

financial assets

financial assets is a claim against the income or wealth of a business firm, household or unit of government represented usually by a certificate, receipt or other legal contested and usually created by the lending of money . example , socks, bond ,policies, deposit in bank etc.

characteristics

1. financial assets promise future returns to their owner

2. it serves as a store of value

3. physical location is not relevant in determine their market value therefore cost of transportation and storage is low

4. financial assets are fungible

kinds or types

financial assets generally fall in to three categories.

1. money 2. equities 3. debt securities

1. any financial asset that is generally accepted in payment for purchases of goods and service is money. example: checking account, currency and coins.

2. equity represents ownership shares of a business firm we can divide equities into common stock and preferred stock.

3. debt securities entitle their holders to a priority claim or over the holder of equities to the asserts and income of an individual, business firm and unit of government usually, that claims is fixed in amount and time and depending on the terms of the contract.

types of financial markets within the financial system

1. the money uersus capital markets

the flow of funds through the financial markets may be divided into different segments depending on the charactersitice of financial clains beingf traded and the needs of different investors one of the most improtant divisions in the finanacial system is between the money markets and the capital market.

the money markets is designed for the making of short-term loans. it is the institution through which individuals and institutions with temporary surplus of funds meet the needs of borrowers who have temporary fund shortages. thus, the money markets enables economic units to manage their liquidity positions.by convention a security or loan maturity within one year or less is considered to be a money market instruments. one of the proncipal functions of the money markets governments with short term function view of fulfilling budget deficit and regulate monetary policy. the money market also supplies funds for speculative buying of securities and commodities. capital markets is desined to finance long term investments by business, government and households. teading of funds in the capital market makes possible the construction of fare highways, schools and homes, investment made in plant and machine etc. financial instruments in the capital market have a original maturities of more than one year and range in size from small loans to multimillion rupees credits.

2. open versus negotiated markets

another distraction between markets in the financail system that is often useful focuses in open market versus negotiated markets. for example,some corporate bonds are sold in the open market to the highest bidder and bought and sold any number of time before they matures and a repaid off. in contrast in the negotiated market for corporate bonds securities generally are sold to one or a few buyers under private contract.

an individual who goes to his or her local banker to secure a loan for a new car enters the negotiated market for auto loans. in the market for corporate stocks operataing the same time, however is the negotiated market for stock in which a corporation may sell its entire stock issur to one or a handful of buyers.

3. primary versus secondary markets

the financial markets mat also be divided into primary markets and secondary markets. the primary market is for the trading of new securities which are never being issued before. its principal function is raising financial capital to support new investment in building, equipment inventories and to meet capital adequacy.

the secondary market deals in securities previously issued. its chief function is to provide liquidity to security investors-that provide an avenue for convertion financial instruments into ready cash. the volume of trading in the secondary market is for larger than trading in the primary market. however, the secondary market does not support new investment.

4. spot versus future funcion and option markets

a sopt market is one in which securities or financial services are traded for immediate delivery. if you pick up the telephone and instruct your broker to purchase share at today's price this is spot market transaction. you expect to acquire ownership of shares with in a matter of minutes or hours.

a future or forwards market is designed to bid contracts calling for the future delivery of financial instruments. for example , you may call your broker and ask to purchase a contract from another investors calling for delivery to you of Rs. 1million in treasury bonds six months from today. the purpose of such contract would be to reduce risk by agreeing on a price today rather than waiting six months, when treasury bond price might have risen.

options markets also offer investors in the money and capital markets an opportunity to reduce risk. these markets make possible the trading of option on selected stocks and bonds, which are agreement's that provide an investor's the right to either buy from or sell designated securities to the writer of the option at a guaranteed price at any time during the life of the contract.

functio preformed by the financial system and the financial markets

the financial system in a modern economy has saver basis function.

1. saving function

financing ACT provides a profitable, low risk outlet for the public saving, which flow through the financial market in to investment so that goods services can be produced and increased society's standard of living.

2. wealth function

wealth is the sum of the values of all assets held by any individuals business firm or government. financial market provides a means to store purchase goods power until needed for future spending on goods and services. wealth can be stored in either purchasing real assets or purchasing financial assets. storing wealth in real assets has more risk associated than that off storing wealth in financial assets because the real assets may exist the loss of assets depreciation etc. the term net wealth is the excess if total value of assets over the total value of debt to be owed. both the net wealth and wealth are built up by a combination of current saving plus income earned on previously accumulated wealth.

3. liquidity function

financial markets provide conversion function for financial securities whenever needed of money with little risk of loss. money consists mainly of deposits held in banks and financial instruments with perfect liquidation. money can be spent without conversion in to some other form. however, money earns the lowest rate of return of all assets traded in financial system and its purchasing power is seriously earned by inflation. that is why savers generally minimize their holdings of money and hold other financial instruments until they really need spendable funds.

4. credit function

credit consists of a loan of funds in return for a promise of future payment. consumers business firms, and government need credit for their own purpose. thus, financial market provides the credit to support consumption and investment spending in economy.

5. payment function

financial market provides a mechanism for making payment for goods and services. checking account, plastic card and other electronic means. serve as a medium of exchange in making payments.

6. risk function

financial markets provides protection to consumers, business and government against risk . this is accomplished by the sale of insurance policies.

7. policy function

financial markets have been the Principal channel through which government has carried out its policy of attempting to stabilize the economy and avoid inflation. by manipulating interest rates and the availability of credit government can affect the borrowing and spending plans of the public, which , in turn influence the growth of jobs. production and prices.

factors affecting dividend policy

many considerations may affect a firm's decision about its dividends, some of them are unique to that company, and some of the more general considerations are given subsequently.
1. desire of shareholders
shareholder may be interested either in dividend incomes or capital gains. wealthy shareholders in a high income tax bracket may be interested in capital gains as against current dividends. a retired and old person, whose sources of income is dividend, would like to get regular dividend in a closed held company, management usually knows the desire if shareholders. so, they can easily adopt a dividend policy that satisfies all shareholders. but in a widely held company, number of shareholders is very large and they have diverse desire regarding dividend and capital gains, some shareholder want cash dividends, while other prefers bonus share.
2. legal rules
certain legal rules may limit the amount of dividends a firm may pay. these legal constants fall in to two categories. first, statutory restrictions may prevent a company from paying dividends. while specific limitations very by state, generally a corporation may not pay a dividend (1) if the firm's liabilities exceed its assets , (2) if the amount of the dividend excesses the accumulated profits, and (3) if the dividend is being paid from capital invested in the firm. the second types of legal restrictions is unique to each firm and result from restrictions in debt and preferred stock contracts.
3. liquidity position
the cash or liquidity position of the firm influences its ability to pay dividends. a firm may have sufficient retained earnings. buy it they are invested in fixed assets, cash may not be available to make dividend payment. thus, the company must have adequate cash available as well as retained earning to pay dividends.
4. need to repay debt
the need to repay debt also influence the availability of cash flow to pay dividend.
5. restrictions in debt contracts
restrictions in debt contracts may specify that dividends may paid only out of earnings generated after signing the loan agreement and only when net working capital is above a specified amount. also preferred dividends take precedence over common stock dividends.
6. rate of assets expansion
a high rate of assets expansion creates a need to retain funds rather than to pay dividends.
7. profit rate
a high rate of profit on net worth makes it desirable to retain earning rather than to pay them out if the investor will earn lesson them.
8. stability of earning
a firm that has a stable earning trend will generally pay a larger portion of its earnings in dividends. if earnings fluctuate significantly, a larger amount of the profits may be retained to ensure that enough money is available for investment projects when needed.
9. tax position of shareholders
the tax position of stockholders also affects dividend policy. corporations owned by largely taxpayers in high income tax brackets tend to ward lower dividend payout where as corporations owned by small investors and tend to ward higher dividend payout.
10. control
for many small firms and certain large ones, maintaining the controlling vote is very important. these owners would prefer the use of debt and retained profits to finance new investments rather than issue new stock . as a result dividend payout will be reduced.
11. access to the capital markets
a firm's access to capital market will be influenced by the age and size of the firm, therefore a well established firm is likely to have a higher payout ration than a smaller, newer firm.

dividend payout schemes

stability or regularity of dividends is considered as a desirable policy by the management of companies. most of the shareholders also perter stable dividends because all other things being the same stable dividends have a positive impact on the market price of the share . by stability we mean maintaining its position in relation to a trend live preferably one that is upward sloping. three of the commonly used dividend policies are:
1.constant dividend per share
constant dividend policy is based on the payment of a fixed rupee dividend in each period. a number of companies follow the policy of paying fixed amount per share as dividend every period, without considering the fluctuation in the earning of the company.this policy does not imply that the dividend per share or dividend rate will never be increased when the company reaches new level of earning and expects to maintain it the annual dividend per share may be increased. investors who have dividends as the only sources of their income prefer the constant dividend policy.
2. constant payout ration
the ration of dividend to earning is known as payout ration. when fixed percentage of earning is paid as dividend in every period, the policy is called constant payout ration. since earnings fluctuate, following this policy necessarily means that the rupee earned, and avoided when it incurs losses.
3. low regular dividends plus extras
the policy of paying a low regular dividend plus extras is a compromise between a stable dividend and a constant payout rate. such a policy give the firm flexibility, yet investors can count on receiving at least a minimum dividend. it is often followed by firms with relatively volatile earning from year to year. the low regular dividend can usually be maintain even when earning decline and extra dividends can be paid when excess funds are available.

dividen policy

companies that earn a profit can do one of the three things:pay that profit out to shareholders reinvest it in the business through expansion, debt reduction or share repurchase or both when a portion of the profit is paid out to the shareholders the payment is known as dividend. there is an ongoing debate about weather a company should pay out its earning as dividends or retain therm for firm growth. there is further debate about which policy investors proper. firms that are view and growing generally pay low or no dividends. mature firm that are no longer in a growth phase often pay high and increasing dividends. management must make a decision about retained as opposed to paid out as dividends the process of paying at "what's left" to shareholders in called dividend policy. dividend policy involves the decision to pay out earning versus retaining them for reinvestment in the firm any change in dividend policy has both favorable and unfavorable effects on the firm's stock price higher the dividends mean's higher the immediate cash flows to inventors which is good but lower future growth which is bad. the dividend policy should be optimal which balance the opposing forces and maximizes stock price.
dividend payments
management should try to maintain regular dividend. for regular dividend the firm will have sufficient earning management will set a lower regular dividend rate then firms with the same average earnings but less volatility. management may also declared extra dividends in years when earning are high and funds are available.
payment procedures
firms usually pay dividend on a quarterly basis in accordance with the following payment procedures:
1.declaration data: this is the day on which the board or directors declares the dividend. at the time they set the amount of the dividend to be paid the holder of record data,and the payment data.
2. holder if record date: this is the data the company opens the ownership books to determine who will receive the dividend. the stockholder of record on this data receive the dividend.
3. ex-dividend data: this data is four days prior to the record data. shares purchased after the ex-dividend data are not entitled to the dividend. only investors who hold the share prior to the ex-dividend data receive the dividend.
4. payment data: this is the day when dividend checks are actually mailed to the holders of record.