Since the ancient times, people used celestial bodies to determine their location on the Earth. Back then, their knowledge about the surrounding world was limited, but still, they had some basic orientation skills. Today we could have easily get lost in the city if not GPS – the system that receives signals from satellites orbiting Earth. There are 30 satellites at an altitude of 20,000 km and as many radars. Radars are ground stations that constantly control the position of satellites. Start devices equipped with the receiver may tell us where the closest satellite is or, which is more useful, how other objects around us are situated in relation to satellites. But only one satellite is not enough to tell you your whereabouts.
At any place on the planet, we have about 3 satellites we can access at a time. As their circles overlap, they can correctly pinpoint one’s location. In a similar way, they detect other objects and calculate how far away they are and what direction we need to take to reach them. Sometimes, there can be more than three satellites accessible in the area that determine the location of objects even more precisely.
Corporate finance is a vast area that deals with essential concepts for every business. If we start a small business, we need finance all the way through. The same refers to large corporations that raise and spend capital to survive in the market and expand. The three fundamental principles of corporate finance are the investment, finance, and dividend principles.
The investment principle implies that businesses need to allocate their funds smartly to get revenue and save money for future. Investment decisions shall be taken carefully as there is always the risks of losing funds or getting little profit. Global allocation of assets is a new trend that stimulates investors to make their money work for them from abroad. Though questioned by domestic companies, the principle is likely to level the risks and increase an estimated revenue for businesses.
The financing principle requires businesses to determine whether they have the right amount of capital and how well they are doing with debts and equity. Changes in capital structure instantly impact the firm’s value and further financial decisions. That is why companies carefully evaluate their financial instruments.
At some point, businesses accumulate money that exceeds their expected hurdle rate. The excess can remain inside the business or it can be given back to the investors. This is the dividend principle that requires rewarding owners for the generated profit.
All these principles are developed for finance specialists to manage the corporate money wisely. The flow of money must assure maximum returns at the lowest risks for the company, otherwise, there is no point in running the business. Corporate finance professionals explore the best way of acquisition and investing for the company to remain profitable.
Factors that determine interest rates put by banks are a rocket science to many people. Banks somehow decide to charge different interests for different customers and different types of loans. In fact, institutions use several models to charge their borrowers taking into account inflation, the level of economic growth, and the monetary policy of the Federal Reserve.
The simplest system of pricing is a cost-plus model. It includes several components that compensate for the expenses and risks of the bank. Here belong the costs paid by the bank to raise funds for lending as well as operating costs paid for servicing the loan (bank’s wages). Banks also charge clients to compensate the default risk essential to the loan request and take a profit margin to ensure an adequate return to the institution.
Besides a common cost-plus approach, some banks also use a price-leadership model of loan pricing. Today banking institutions compete for loans and deposits narrowing the profit margins for each other. In such case, major banks establish a base rate charged to customers on short-term loans. To run a profitable business, a banker must keep funding and operational costs as low as possible, to stay competitive in the market.
Some banks also use a risk-based pricing, which means putting a default premium on the loan. It is a problematic technique of pricing though as risks greatly depend on the characteristics of the loan and on the borrower. Banks find optimal rates and offer competitive prices on loans for all borrowers, rejecting the loans representing the highest risks. Lenders use credit-score software to analyze data from a large community of borrowers gathered by major credit reporting agencies.
Due to some natural reasons, investors begin to question the necessity of global asset allocation. Political issues like Brexit and the obscurity of the foreign market urge investor to rely on the predictability of domestic economy. Home-country bias makes us believe that we know our domestic markets best, and there is very little chance to fail there. But there is always some chance to fail everywhere, and it makes no sense to dismiss diversification. About a half of all global enterprises are based outside the US, and investors who ignore diversification limit their opportunities by half.
Getting higher performance is the main advantage of investing abroad. Though the US markets perform well on average, they are not protected from internal threats. A diversified portfolio benefits from owning top performers and does not bear heavy losses from bottom performers. In the long run, a diversified portfolio balances high and low incomes, and the returns are generally greater than in non-diversified portfolios.
The benefits of diversification were first outlined in Modern Portfolio Theory published in 1952. It suggests that an investor can construct a portfolio of numerous assets to increase the return at the current level of risks. A diversified portfolio bears fewer risks than its every single part does. Even under the conditions of market stress, diversification allows to level the risks and boost the expected revenue for the investor.
Financial regulation came as an essential issue after the global financial crisis. Economies need to stay resilient facing domestic and external financial shocks, which is especially urgent to the emerging markets. In general, developing economies seem to be less affected by the global crisis as compared to their advanced counterparts. They concentrate on strengthening banks and expanding financial system while developed economies need to take more sophisticated steps to keep their economic balance. Nevertheless, emerging markets need to learn on crisis and create effective strategies to expand their economies further.
In the developed countries, a common approach to financial regulation lies in combining rules-based and principles-based regulation. But it is important to reconsider basic principles in favor of innovation and risk taking. Higher capital requirements can ensure higher stability for financial institutions during the crisis. Accounting standards shall be reconsidered not to exacerbate systemic problems when the requirements are high. Financial firms have to manage liquidity risks and limit leverage to prevent a systemic breakdown. It is also a good idea to bring more derivative products onto exchanges to trade transparently. Creating smart resolution mechanisms for failing financial institutions is also relevant for the developing countries. Huge government bailouts distress economies even more during the crisis so it is time to allow financial institutions to fail in an orderly manner.
Many of these issues are relevant for emerging markets too, but it can be difficult to adapt them for every specific country. Strengthening the institutional framework is the top priority for the emerging markets. Developing countries need a higher regulatory capacity to keep pace with more advanced markets and their products. They shall pay closer attention to the regulatory reform agenda and financial development agenda to withstand the economic challenges from outside.