BUS FPX 3062 Assessment 1 Financial Management and Markets

BUS FPX 3062 Assessment 1 Financial Management and Markets

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Capella University

BUS-FPX3062 Fundamentals of Finance

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Understanding Financial Management and Ethical Considerations in Markets

Financial management is a crucial aspect of any business, influencing decision-making and ethical practices within the market. In this article, we will delve into various facets of financial management, including ethical considerations highlighted by the case of Martha Stewart, the importance of wealth maximization over profit maximization, market classifications, the yield curve, and risk premium calculations.

The Martha Stewart Case: Insider Trading and Ethics

Martha Stewart’s involvement in insider trading raises significant ethical questions within the realm of financial management. Although Stewart was accused of selling ImClone stocks shortly before their value plummeted, the charges of securities fraud were ultimately dismissed. Instead, she faced a five-month prison sentence for obstruction of justice and lying to investigators.

Was Insider Trading Unethical?

The ethics of Stewart’s actions remain debatable. Her broker informed her that ImClone’s CEO was selling shares, which suggested that she should do the same. This advice was based on publicly disclosed information, so it’s not inherently unethical. However, the subsequent actions she took to conceal her decisions reflect a clear ethical breach, highlighting that transparency is paramount in financial management.

Wealth Maximization vs. Profit Maximization

The Case for Wealth Maximization

Wealth maximization is often viewed as a superior goal compared to profit maximization. While profit maximization may boost shareholder equity in the short term, it can lead to decisions that jeopardize long-term returns. According to financial expert Cornett (2021), a long-term focus not only secures the best returns but also fosters sustainable growth.

In contrast, prioritizing profit can encourage risky behaviors, ultimately diminishing value. A company that adopts wealth maximization as its guiding principle aligns its strategies with the long-term interests of its shareholders, ensuring stability and growth.

Primary vs. Secondary Markets: Classifying Transactions

Understanding market classifications is vital for effective financial management. Below are examples of transactions categorized into primary and secondary markets.

Understanding Market Dynamics

Primary markets are where new securities are created, while secondary markets deal with the trading of existing securities. This classification helps investors understand where their capital is flowing and the lifecycle of securities in the financial ecosystem.

Classifying Financial Instruments: Money Market vs. Capital Market

Financial instruments can also be categorized into money market securities or capital market securities. Below are classifications for various instruments:

Significance of Market Classifications

Understanding these classifications is essential for making informed investment decisions, as they impact liquidity, risk, and return potential.

Analyzing the Yield Curve

The yield curve, a graphical representation of interest rates over various maturities, can be understood through two theories: the Unbiased Expectations Theory (UET) and the Liquidity Premium Theory (LPT).

Unbiased Expectations Theory (UET)

According to UET, the yield curve slopes upward if future one-year rates are expected to rise, remains flat if rates are anticipated to stay constant, and slopes downward if future rates are predicted to fall.

Liquidity Premium Theory (LPT)

LPT posits that long-term rates equal the geometric averages of current and expected short-term rates, adjusted for liquidity risk premiums that increase with maturity. This theory suggests that an upward-sloping yield curve may arise from expectations of rising future interest rates, a flat curve, or even falling rates, provided that liquidity premiums adequately compensate for increased risk.

Calculating Equilibrium Rate of Return

To determine a security’s equilibrium rate of return, consider the following risk premiums:

• Default Risk Premium: 2%
• Inflation Risk Premium: 1.75%
• Real Risk-Free Rate: 3.50%
• Liquidity Risk Premium: 0.25%
• Maturity Risk Premium: 0.85%

Calculation

The formula for calculating the equilibrium rate of return is:

[ 2\% + 1.75\% + 3.5\% + 0.25\% + 0.85\% = 8.35\% ]

This means the security’s equilibrium rate of return is 8.35%.

Conclusion

Financial management encompasses ethical considerations, market classifications, and risk assessments. The case of Martha Stewart exemplifies the complexity of ethical decision-making, while understanding wealth maximization is crucial for sustainable growth. Additionally, knowing the distinctions between primary and secondary markets, as well as the types of financial instruments, empowers investors to navigate the financial landscape effectively. Finally, grasping the yield curve and calculating equilibrium rates are vital skills for anyone involved in finance. By prioritizing these concepts, individuals and companies can foster better financial management practices that align with ethical standards and long-term success.

References

By The Associated Press. (2014, August 15). Timeline of Events in Stewart Stock Scandal. Chicagotribune.com; Chicago Tribune. https://www.chicagotribune.com/sns-apmartha-stewart-chronology-story.html 

BUS FPX 3062 Assessment 1 Financial Management and Markets

Cornett, M. M. (2021). M: Finance (5th Edition). McGraw-Hill Higher Education (US). https://capella.vitalsource.com/books/9781264109685