Question

Identify and discuss the six “pillars” or “principles” of finance (refer to chapter 1). Explain how these pillars help organizational leaders make financial decisions.

-Money has a time value

-Higher returns are expected for taking on more risk

-Diversification of investments can reduce risk

-Manager and stockholder objectives may differ

-Financial markets are efficient for pricing securities

-Reputation matters

Answer 1

1) Money has a time value

It means whether the money available in future is more or less than money present today. It helps organizational leaders to make financial decisions as it may seem that the money expected to flow in organization is greater than the money present today, but it may not be always true. It helps in leaders to know the present worth of an investment and whether it will be profitable or not; if not profitable, other investment can be done.

2) Higher returns are expected for taking on more risk

As the organization takes more risk in an investment, it will have very high probability of failure, so as the probability of failure increases, the expected return on it also increases and the organization will seek more return in order of taking more risk

3) Diversification of investments can reduce risk

When an investment is diversified, it means the funds are allocated in different alternatives which may or may nor be related to each other. Hence, when an alternative fails, the other alternative have still chances of success; it means the risk has been reduced by diversification.

4) Manager and stockholder objectives may differ

Everyone aim to increase their wealth, be it manager or stockholder. In order to fulfill their own aim, the objectives may differ as manager would like to increase his salary or invest more in operation whereas stockholder would aim to increase their wealth by maximizing equity value and market value of organization.

5) Financial markets are efficient for pricing securities

Financial markets are efficient for pricing securities as the price of securities depend on its demand. When the demand increases for these securities, the prices shoot up and vice-versa. Hence, it is said that financial markets are efficient for pricing securities and financial market auto balances the price of securities

6) Reputation matters

Reputation matters the prime most in finance as if the firm have good reputation in the market, the investors will trust the firm and will easily invest in the firm to get more return. Good reputation makes it easy for firm to raise capital, attract more investors, invest well in different projects