Financial Services and Banking System Analysis: UK

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Financial Services
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Contents
LO1............................................................................................................................................3
1.1 (a) Appraise the available sources of corporate finance...................................................3
(b) Evaluation of various sources..........................................................................................4
(1.2) Explain the time value of money..................................................................................5
1.3 (a) wealth maximisation of shareholder is superior to profit maximisation.....................5
(b) Indicators used for measuring shareholders value............................................................6
2.1 (a) Difference between active and passive funds.............................................................7
(b) Portfolio theory application beyond finance.....................................................................8
3.1 (a) Brief description of banking system and economic features of UK........................10
3.1 (b) description of banking system of UK.......................................................................10
(c) Services commonly offered by the modern commercial banks in UK...........................11
3.2 ECB’s strategies and tools-............................................................................................12
References................................................................................................................................13
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LO1
1.1 (a) Appraise the available sources of corporate finance
As an advisor, I would suggest to Mr. Bill to follow these sources of financial corporate.
There are top seven sources of corporate finance, these are as follows –
Shares
Shares can be two types. Equity shares and preference shares (Petajisto, 2013). Equity shares
are ordinary fro company’s business. It is also known as ordinary shares. The holders of these
shares do not enjoy dividend and repayment of capital. If the company gets profits then the
shares holders of the company are paid dividend from this profit. Preference shares holders
do not have any voting rights. These stock holders generally have fixed dividend. They may
claim the voting rights if the dividend are not paid by the company for two years. It is similar
to the debentures because dividend is fixed and do not have voting rights.
Debentures –
In corporate finance, debenture is a medium for debt format in that large company is used to
borrow money. It is most typical form of long-term loans for a company (Petajisto, 2013).
Debentures holders are not allowed to vote in the company’s general meetings of
shareholders.
Public deposits –
This source invites public deposits to make advertisements. It refers to unsecured deposits for
public which is invited by the company for its capital needs.
Banks –
Banks play an important role in corporate finance. Generally banks provide mid- term and
short-term loans. Investment bankers raise money to develop the business.
Indigenous banks –
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It can be private or individuals. To receive deposits and give loans, bank operate in both the
situations. This is not related with homogeneous category. Indigenious bankers can be
related to number of banking and non-banking functions (Petajisto, 2013).
Retained earnings –
It is related to the net income of a business. It is also known as accumulated earnings. In
business, earning can be negative or positive. Through positive earnings company can utilize
surplus money earned. If the money is not paid to the shareholders then it is counted as
retained earnings.
RE = beginning period RE + net income( or loss) – cash dividends – stock dividends
Special financial institiution –
Financial institutions involve central banks, commercial banks, internet bank, brokerage
firms and mortagage companies. There are four types of financial institutions. First,
commercial banks are the oldest and largest fianancial institutions. They rely on checking as
well as saving accounts because it is a source of funds for loan to business. Second is saving
and loan associates, so that they can use that saving as a capital to make loans. Third is credit
unions, which provides savings and other services at minimum fees. Brokerage fir m is the
fourth type of financial institution. Its function is to buy and sell stocks, bonds and other
securities for their customer (Petajisto, 2013).
(b) Evaluation of various sources
Mr. Bill has a mature business that he is passionate to grow to the next level. As an advisor
Mr. Bill must understand the parameters and the best way to subsidize financial needs to
grow to the next level. Any small business starts with 4 F’s, friends, family, founders and
fools. Accept the close network; banks are the first source Mr. Bill can approach for further
investment. Competitions are another intresting way for early funding. He also may seek
funding from joint venture and international interest. He needs to consider equity, control,
security, transferability and team as major sources for evaluation.
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(1.2) Explain the time value of money
Time value of money concept means the cash received today is more valuable than in the
future. If a person aggress to receive payment at the later date, will leads to invest that cash
right now (Lusardi and Tufano, 2015). If someone agrees to delay payment is known as
interest income. Time value of money explains that why interest is paid or earned. This
concept is important for an investors.
For example.
If the person choose between getting $600 now or getting $ 600 a year from now, most
people will choose to take money now.
There are three reasons why cash received in future is worth less than today.
Individuals prefer present consumptions rather than future consumptions.
The value of currency decreases over time when there is monetary inflation. If the inflation
rises the difference in value between cash today and cash tomorrow.
Loans and leases related problems can be solved by this concept.
There are five factors needed to calculate time value of money. These are future value,
payments, present value, annual interest and number of time period that can be in months or
years. Time value of money impact on inflation because it decreases the value of money over
time. Three techniques can solve the time value problems. These are present value
calculations, future value calculations and recurring value techniques.
1.3 (a) wealth maximisation of shareholder is superior to profit maximisation
Shareholders invest money in a company for better returns. These are the actual owner of the
company. If a company takes any decision, that decision is made with the shareholders
wealth maximisation. Company does not increase its size to see its employees get rich its
maximise the return for shareholders of the corporation (Lusardi and Tufano, 2015).
The wealth maximisation is superior rather than profit maximisation because longer
assessment can lead the business to perform sustainable. Two reasons why wealth
maximisation is superior than profit maximisation is, first different aspects of profit leads to
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different decisions. Another is through profit maximisation there can be expense of profit in
short term. Profit maximisation is the main objective of every organisation. Its purpose is to
increase sales and profit. Very less importance is given to the consumer in profit
maximisation method. Through this organisation can be successful by achieving its goal of
earning profits but in future it will suffer loss (Lusardi and Tufano, 2015).
Wealth maximisation increases goodwill and importance of consumer. Through consumer
importance, organisations get different queries; need to change in products that lead to
product and service quality.
(b) Indicators used for measuring shareholders value
It is necessary to create shareholders value in market. This is key to success. Corporate
employees consistently manage and report of shareholder value on regular basis. Shareholder
value describers the financial worth owner of a business receive for owning shares in the
company. When the business perform better than they expect shareholder value created by
this (Lusardi and Tufano, 2015).
There are five indicators that are used by the investor
Middle manager and frontline employees should be rewarded for their superior performance
on value drivers that influenced directly.
To bear the risk or ownership, required senior level executives, like shareholders do,
To provide value relevant information to the investor.
To carry the assests only because it maximises the value.
Company shoul not manage or provide the guidance about earning.
The prime omportance for the management of the company is to increase the shareholder
value. The higher the shareholder value, the company and management will be better form.
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2.1 (a) Difference between active and passive funds
Investment funds that are actively managed by management team, tells about how to invest
the fund’s money (Gitman, et. al., 2015).
Active investment Passive investment
It is based on in depended analysis of each
investment
It is based on investor’s portfolio that is
formed by market portfolio.
Its objective is to focus on absolute return by
beating the market performance
Its objective is to match market performance.
This also relates to relative returns.
In this investing the investor perceive market
to be inefficient.
In this the investor thinks about efficient
market.
Transaction frequency is higher by buying
and selling.
It is comparatively low, because of changes
in the index compositions.
Active investing is more risky but gives
higher returns.
It is less risky and gives lower returns.
Actives investment involves the higher cost. This shows lower costs and tax efficiency.
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Example of active investment with Abraaj Group, UAE
The Abraaj Gruop focuses on well managed, mid market leaders in sectors for demand and
expansion of young urban. Consumer goods and services, infrastructure services includes in
these sectors. This group is an international investment firm investing in emerging markets
(Gitman, et. al., 2015).
In 2014, CDC invested $ 50 miilion ino Abraaj Africa Fund III. This closed at $990 million,
so investment provided by CDC gained growth capital for mid- market in key territories.
Example of passive investment in safanad,UAE
This is a global investment firm that invest directly in real estate and private equity
transations. Safanad grows its wealth a investment approach an disciplined this is build by
relationships with top industry leader.
Safanad has executed$10 million of transactions value in Europe and U.S. across sectors like
education , healthcare, student housing and data centres.
(b) Portfolio theory application beyond finance
A portfolio, in terms of finance is a combination of different types of assets. It can be
securities, deposits, foreign currency and gold etc.
The main two importance of creating the portfolio are diversification of risk and profit the
inverstor. This theory was found by Harry Markovitz in1952 (Gitman, et. al., 2015). Portfolio
theory simplifies trading with securities. Diversification of risk means to reduce risk. It is
explained through this sentence “Never put all your eggs in one basket”. It advises the
investors should not invest their capital in one area if financial crises come up because it
leads to the risk. So investor should invest their capital into variety of instruments. This
process of spreading risk and minimum chances of total loss is called “Diversification”
(Gitman, et. al., 2015). By creating a portfolio of securities or derivatives an investor needs to
do much more analysis and effort of the same. According to attachment 1,Warren Buffet has
said that “derivatives are financial markets” weapon of mass destruction. Modern portfolio
theory offers quantitative way to choose investment so that the portfolio makes tradeoff of
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reward versus risk. Financial derivatives can be correlated in terms of their prises move in
opposite direction. If the investor follows the portfolio theory, he can reduce the possibility to
decrease the risk. Portfolio framework is an internal viewpoint whereas market equilibrium
framework is an external viewpoint to measure the risk margin (Bartlett III, 2014). There are
two concepts which a investor should use to build portfolio. (1) if an investor wants greater
returns, then he will need to take more risk. So risk and return are directly connected. (2) a
portfolio’s overall risk depend on diversification of security, if it do not behave alike. In case
if an investor has two portfolios then it will offer the same expected return.
Source: (Bartlett III, 2014)
We can understand by this graph. It simplifies that an investor gets same return on lower risk
(AB) and in (AC) he is having the same risk but the return which he is earning higher returns
only through the portfolio theory. So in conclusion regarding attachment1 is, if we use these
powerful tools in a controlled way the power they can provide is virtually unlimited (Bartlett
III, 2014).
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3.1 (a) Brief description of banking system and economic features of UK.
UK banking system consists of around 340 or more than 340 commercial banks including
bank of England because it is the economy’s central bank. UK banking systems of classic
version of two- tier system. It is the oldest and most advanced systems in the world (Bartlett
III, 2014). The most important trend in banking system of Great Britain is blurring of the
boundaries between different types of lending institutions. The United Kingdom comprises
four graphical and historical parts that is “ England, Scotland, Wales and Northern Ireland”.
It is located on the coast of mainland Europe. The name Britain sometimes used for UK as a
whole. Te capital of UK is London, which is world’s leading commercial, cultural and
financial centres. In technology and industry, UK has made significant contribution to the
world.
Economic features of UK
United Kingdome is a developed country that offers economic security and high quality of
life to its population (Bartlett III, 2014). Services in the UK are increasing important to
economic output. Knowledge economy involves development of valuable knowledge like
procedures, methods, formulations and software. This leads to the creative output for brand.
Common characteristic of a developed economy are low birth rate, well trained workforce
and export high value added goods. Through low per capita income UK economy can define
clearly. UK economic prosperity is political and social stability.
3.1 (b) description of banking system of UK
UK banking system plays an important role in the development of economy. Banks provides
the savings of a individuals to business people and manufacturers by collecting savings from
them. Money can be created through banking systems. Banking system of UK involves
internal as well as international trade. All the trades is done in terms of credit. Some kinds of
banks provide different kinds of economic activities. In UK there is a bank of England, which
is economy’s central bank. It controls the activities of all the banks. UK banks offers sale of
shares and debentures (Bartlett III, 2014). The banking system in UK is two- tier system as
well as most advanced system in the world. In UK, the banking system has many
characteristics that reflects historical development of system. The three main unique
characteristic of UK banking are the structure of central bank, multiple agencies for
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regulations and dual banking system.countries like UK grows faster through better
development of financial system. Both teh stock market liquidity and development in banking
levels has main role in economic growth. Better the functioning system, better expansion of
industry. UK central banks promote economic growth with stability.
(c) Services commonly offered by the modern commercial banks in UK
Banks are the most important part of UK. In modern time money is very important. A
modern commercial banks provides valuable service to UK. Commercial banks are the king
pin of the financial system of UK. They provide many valuable services. Commercial banks
provides banking services to consumer as well as to the business through its network of
branches. Commercial banks are owned by the government. Commercial banks are all
purpose services such as consumer loans, proving brokerage services, demand deposits,
buying and selling foreign exchange and so on.
Functions or services of commercial banks are as below,
Primary functions –
(a) Makings loans and advances –for legal reserve, commercial banks have to keep some
of its portion of deposits (Amihud and Goyenko, 2013). The balance which is
remained after keeping for legal reserve that is used to make loans and advances for
borrowers. Some firms and individuals may borrow money from banks and by
charging interest on that money, banks make profits.
(b) Collection of deposits – its main function is to collect money from the public. These
deposits can be divided into three types – current account, saving account and fixed
and term deposit.
(c) Agency services – the banks collects cheques, drafts and bills on behalf of the
customer. It also changes domestic currency into foreign currency as per regulations.
Payments are made from customer account in such services like payment of rent,
insurance premium, telephone bills and instalment of hire purchase.
(d) Credit cards – it is another mode of making payments master card and visa are
operated by the commercial banks (Amihud and Goyenko, 2013).
(e) Automatic teller machine – ATM’s are for the quick withdrawal of cash. Modern
bank has introduced this facilities in metropolitan and semi – urban area.
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3.2 ECB’s strategies and tools-
Primary objective of ECB is to maintain price stability. The monetary policy tool of ECB
is collateralised borrowing and repo agreements. The operational framework of euro
system describes some instruments which are standing facilities, minimum reserve
requirements for credit institutions (Amihud and Goyenko, 2013). These are the
monetary policy instruments. ECB has started to buy bond of eurozone governments in
march 2015. As far as economic outlook is concern, big question for the investors that
ECB will cut its growth forecasts and what type of tool it might use for next year growth.
The ECB’s monetary policy involves a quantitative definition in stability of price and two
– pillar approach to analyse risks. The external communication strategy is used for
diversified approach. ECB’s price stability is to be maintained. Its governing council has
defined price stability with respect to inflation that should below 2%. Two-pillar
approach is the best to maintain price stability. In this approach the ECB thoroughly
analyse economic development. ECB has the three main decision making bodies that are
Governing Council, Executive Board and General Council. Central banks mainly have
three monetary policy tools: open market operations, the reserve requirement and the
discount rate. ECB’s sets key interest rates and manage liquidity situation through money
market condition. So in conclusion “Trust in central banks” ability to influence the
inflation rate may have eroded (Amihud and Goyenko, 2013).”
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