Question

Describe Financial Markets and Ratio Analysis?(In atleast 200 words)

Answer 1

A) Financial market is a market place for buyers and sellers of stocks, bonds, derivatives, futures, options and commodities. It is a place where investors earn from their investment and where companies raise their capital funds for the business or to obtain loans or to hedge the risk of future transactions or currency exposures. It includes -

1) stock market - where share of ownership of companies are sold in market and depending upon the actions and decisions of both buyers and sellers concerned and on their perceptions of profitabilites, the shares are being traded.

2) Bond market - it is a financial market where the companies issue bonds to raise huge amount of loans. The companies issue bonds primarily to the buyers is called primary market and thereafter the Willing buyers and sellers trade the bonds in secondary market. There are many types of bonds traded in bond market though like treasury bond, corporate bonds, municipal bonds etc.

3) commodity market - it is the market where companies hedge the risk of their future transactions since the price of the commodities can change in future and can cause a probable loss in future the transaction are hedged by another transaction in commodity market to ensure no loss. Many investors though trade in commodity market simply to make profit by forecasting the future market.

B) Ratio analysis is a method of calculating financial ratios based on the items presented in profit and loss account and balance sheet based on which the reasons for the current financial position of the business are analysed. These are the mathematical indicators which helps a person to identify and develop a future outlook of business financial position. It is also a useful tool to compare the financial position of two different businesses or compare the present scenario of a business with past trends.

Ratio analysis can be broadly classified into 3 categories -

1) liquidity ratio - these ratios show cases the liquidity position of a business which means the cash available and cash equivalents in the business. These are basically important for the stakeholders like creditors to identify the credibility of business, to employees who can ensure the timely payment of their salaries or to banks to ensure the timely payment of their short term loans.

These ratios include -
Current ratio
Quick ratio

2) solvency ratio - these ratios assess the long-term financial viability of a business or its ability to pay off its long-term obligations of banks, debenture holders etc. These ratios are of importance to banks and debenture holders to assess the repayment of their loans in due course.
These ratios include -
Debt ratio
Debt equity ratio
Debt to asset ratio
Current debt to inventory ratio
Total liabilitie to net worth ratio

3) profitability ratio - this is another important category of ratio of a business to assess the ability to business to earn profits for its owners.
These ratios include -
Net profit margin ratio
Gross profit margin ratio
Return on asset
Return on equity

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