Question

Problem 6 –

For each of the items below provide a brief description of the SIGNIFANCE (usefulness/importance). Several sentences for each should be all that you need.

a. Identify and a sentence or two reflection for each. The three factors that are used to develop a forecasted required rate of return.

b. The significance of the statement of cash flows (don’t just list the three sections) discuss the SIGNIFICANCE (usefulness/importance)


c. The Role of Financial Markets

Answer 1

(a). Factors that are used to develop a forecasted required rate of return: Here, we have to discuss three factors that are required to develop forecasted required rate of return, these are Real rate of return, Inflation and Risk Premium.

(i). Real Rate of Return: It is the rate of return which is adjusted for the inflation risk it is the actual realized reate of return on an investment. It is adjusted for nominal return for inflation and price changes.

(ii). Inflation: It is the percentage changes in prices of basket of goods and services. Due to changes in the inflation the price of goods changes, which erodes the value of investment held. Required rate of return doesn't factor inflation expectations since rising prices reduces value of investment over time.

(iii). Risk Premium: It is the premium received by any investor by taking risk in investing into the funds.If the risk is higher in any investment the premium received should also be higher to compensate the risk assumed by the investor in investing such funds.

Risk Premium and Required rate of return both are directly proportional to each other.

(b). Significance of Statements of Cashflows: As the name suggests the Statement of Cashflows gives the information about the company cash position during a particular period, which also gives the relevant understanding about the companys cash structure and the performance of the operational activities in a given period.

• It is important because cash is a key requirement for any business to stay solvent.
• By focusing on the Cashflow statement one can easily understand which activities of the business has an impact on the cash position during that period.  
• It is very useful for financial planning, because it gives the information about the operational excellence of a firm.
• It aslo gives an idea about a company's earning capacity and its spending.
• Providing information about the Operating cashflows and Financing cashflows it gives an idea about the critical importance of these areas.
• Creating excess cash.

(c). Role of Financial Markets: Financial Markets play very crucial role, it helps meet the people who are in need of funds to those who are having surplus funds. People reaching their retirements are having surplus money and the firms that are having future investment proposals are having need of those funds. Financial markets helps meet these peoples and thus makes a balance between these peoples, which is also known as mobilization of funds.

Financial markets lead to an efficient allocation of resources through information conveyed to investors.

It also helps maintain liquidity in the market, thus provides the investor with a facility to buy and sell the securities at its fair value.

It also gives a way to risk sharing among investors. Persons who have undertaken the projects to who have bought those securuties these peopls shares the risk.

It also helps in the capital formation for the country by providing relevant infrmation about the new savings.