Financial Management: Understanding Interest Rates and Market Dynamics

This assignment provides a comprehensive overview of key concepts in financial management. It begins by classifying transactions in primary and secondary markets and identifying different types of financial securities, categorizing them as either capital market or money market instruments. The assignment then explores various types of financial institutions, including commercial banks, thrifts, insurance companies, securities firms, finance companies, mutual funds, and pension funds, highlighting their unique roles and functions. It further discusses the concept of liquidity and its importance in financial management. The assignment also examines factors influencing interest rates, such as inflation, real interest rates, default risk, liquidity risk, special provisions, and time to maturity. Finally, it delves into the term structure of interest rates, explaining the unbiased expectations theory, liquidity premium theory, and market segmentation theory, and illustrating a normal yield curve. Desklib offers a platform to explore more solved assignments and study resources for students.

Running head: Financial Management
Financial Management

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Table of Contents
Question 1.............................................................................................................................................3
Question 2.............................................................................................................................................3
Question 3.............................................................................................................................................3
Question 4.............................................................................................................................................5
Question 5.............................................................................................................................................5
References:............................................................................................................................................7

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Question 1
1) P&G; sells $5 million of GM preferred stock from its marketable securities portfolio.
Secondary Market
2) The Vanquish Fund buys $100 million of previously issued P&G; bonds. Secondary
Market
3) Gecko Insurance Co. sells $10 million of GM common stock. Secondary Market
4) Ford Motor issues $200 million of new common stock. Primary Market
5) The Betterment Company issues $50 million of common stock in an IPO. Secondary
Market
Question 2
1) Mortgages – capital market security
2) Common Stock – capital market security
3) Corporate Bonds – capital market security
4) Banker's Acceptances– money market security
5) U.S. Treasury Bills– money market security
6) Commercial Paper – money market security
7) U.S. Treasury Notes and Bonds – capital market security
8) State and Local Government Bonds– capital market security
9) U.S. Government Agency Bonds – capital market security
Question 3
Types of Financial institutions:

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1. Commercial Banks: They offer commercial, personal, real estate and other types of
loans. They also offer loans to other depository institutions. Their whole sole liability
is only of deposits.
2. Thrifts: These are savings banks or savings association. They hardly focus on one
type of loan that can be consumer loans or real estate loans (Titman, Keown &
Martin, 2017).
3. Insurance companies: They are the c0mpanies that provide insurance cover for the
health and life of any human being but subject to some terms and conditions. Their
motive is to provide protection to the corporations and individuals from any accidents
and life events.
4. Securities firms and investment banks: Their work is to underwrite the securities and
sell the investments outlays to individuals and corporations. Their major earning is
from brokerage and trading.
5. Finance Companies: Finance companies issue long term and short term loans to
individuals and companies. They are not involved in the deposits like commercial
banks accept. The loans that are given by the finance companies are usually for the
durable goods like TVs, cars and washers/ dryers.
6. Mutual funds: They pool the money of different individuals and use the money for
further investment in the asset portfolios (Cole, 2004).
7. Pension funds: The money earned as a part of salary or wages and money that is
transferred to a savings account throughout the employees working years. The money
that is saved in pension fund can then be withdrawn after retirement.
Liquidity means the capacity of the company to repay its short term liabilities as and when
needed. In short we can say that the capacity of any company to convert the asset into cash
can be termed as liquidity (Brigham & Ehrhardt, 2013).

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Question 4
 Inflation: Inflation means there is constant rise in the price of the goods and services.
 Real Interest rate: It is the rate which is adjusted for inflation. This rate is less than
nominal interest rates.
 Default Risk: The risk that the issuer of security will skip the payment of interest or
principal or failure of the issuer to repay such payments.
 Liquidity Risk: This is all about the risk involved in the security at the time of sale if
the time period is short.
 Special provisions impact the security holder with good or bad impact and this is
shown in the interest rate of the securities.
 Time to maturity is the span of time until and unless a security is repaid.
Inflation and Real Interest Rate are the two factors common to all financial institutions (Barr
& McClellan, 2018).
Question 5
Term structure of interest rates shows the connection between the maturity period and the
interest rates. It is also known as the “yield curve”
Unbiased Expectations Theory – This theory says that at any given point of time, the yield
curve imitates the current market potentials for short-term rates of future.
Liquidity Premium Theory – This theory says that the investors will hold the long term
interest bearing securities only if these securities compensate the vagueness in the security
value for the future with some premium amount.
Market Segmentation Theory – This theory is about the maturity of the securities and
investors potential to hold them.

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Normal Yield Curve – Up-sloped.

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References:
Barr, M. J., & McClellan, G. S. (2018). Budgets and financial management in higher
education. John Wiley & Sons.
Brigham, E. F., & Ehrhardt, M. C. (2013). Financial management: Theory & practice.
Cengage Learning.
Cole, G. A. (2004). Management theory and practice. Cengage Learning EMEA.
Titman, S., Keown, A. J., & Martin, J. D. (2017). Financial management: Principles and
applications. Pearson.