Strategic Financial Management - Essay Example

Strategic Financial Management Table of Contents Strategic Financial Management Table of Contents 2 Introduction 3 Efficient capital markets and Financing decisions 3 Conclusion 5 Reference 7 Introduction “Capital markets are places where companies which need long-term finance can meet investors who have finance to offer” (Pearsoned, n.d.). Finance can comprise of issuance of the new ordinary shares, equity financing, and debt financing (Pearsoned, n.d.). In the debt financing, the organisations have the option to choose from a broad range of the loans and various debt securities as per their requirements. In the capital markets, the investors are able to buy and sell government and corporate securities as per their risk appetites. The trading decisions of the investors reflect the available information on the performance of the organisation inferred from the financial statements, dividend announcements, prospective interest rates, inflation rate, market expectations, growth opportunities and investment decisions of the respective companies. This report aims to provide an in-depth insight into the efficient market concept and the nature of financing decisions in such a market. It also comprises of the discussion on the efficient capital markets where it is difficult to incorporate intelligent financing decisions that add value by exploring new profit opportunities. A conclusion has been inferred from the analysis of the efficient capital markets to push the debt and equity prices to be fairly priced. Efficient capital markets and Financing decisions Both the investors and the organisations want the securities, which are being traded in the capital market, to be fairly priced. The desirable features of an efficient market can be explained using the relation between the market prices and the information available in the capital market. An efficient market is a market where the prices of the securities fully reflect the available information (Simon Fraser University, 2010). The market prices absorb the security prices rapidly, as early as the information on the organisations are available in the market. As per the efficient market hypothesis, the market efficiency refers to both the magnitude and direction of the price amendments. This is done by absorbing the new information available in the market. Different intensities of the market efficiency have led the capital markets to be segmented into different efficiency forms. The efficiency level of an efficient market can be of three types; weak form efficiency, semi strong form efficiency and strong form efficiency. Capital markets have weak form efficiency if the current securities prices in it reflect certain historical information. The semi strong efficient markets reflect the past price movement in the securities and at the same time represent all currently available public information. The strong form capital markets reflect all the public and privately available information related to the securities (Sloan School of Management, 2003). However the analysis here would consider the characteristics and behaviour of the strong efficient capital market. One of the typical financing decisions of a firm includes decisions on the issuance of the equity and debt securities. The implication of an efficient capital market means that the market prices reflect all the available information needed to have a fair pricing of all the existing securities (Chuvakin, n.d.). As the purchasing and selling of securities takes place at the prevailing market price, the transaction would never result in positive net present value. Creating value through financing is difficult in an efficient market (Brealey & Myers, 2003). As the investors have enough information available with them, the organisations can not make profits by fooling the investors consistently. Firms can decide on reducing the costs or increasing the subsidies. They can make certain form of financing which would have tax advantages or would carry certain other subsidies. This does not seem to be a feasible approach as the procedure is quite costly and would reap only one time benefit. Sometimes the firms even introduce new securities to convince previously unsatisfied investors. They offer these new securities at a much favourable prices. This is achievable in the short run, but is not feasible to be implemented as a part of long term strategy. It would be better to analyse the efficient market scenario from the investors’ perspectives. In a capital market, investors are given the option to choose from a variety of securities as per their risk appetites. According to the Capital Asset pricing Model (CAPM), the expected return of the securities is defined by Expected return = Risk Free return + Beta * (Market rate- Risk Free return). in an efficient market all the information is available to all of the investors, which means the beta value would be of 1. This also implies that all the securities in the market will move along with the market itself. In such a scenario, the investors would demand the market value of the securities they hold. Even, in today’s extremely competitive milieu, it has been quite difficult to explore the profit opportunities. As the competition has grown fierce in recent times, investors are now keener to fetch the required information related to the securities. Such eagerness has encouraged the market to become more efficient in coming days. As the investors are trying to acquire more market information, the market is growing more efficient by absorbing new information about the respective securities. From the above analysis, it will not be wrong to say that both the intensity of competition between the investors and the level of market efficiency are moving in the same direction to reap the pertaining profitable opportunities in a market scenario. Conclusion Characteristics of an efficient market include prompt operational activities and pricing efficiency. The sales in this market need to be done in a rapid pace, which means that the market demands the transaction cost to be low. The securities prices are supposed to reflect all the information available in the market and hence should introduce fair pricing in the market. Since all the information is available to all of the players in the capital market, there would be fierce competition to explore any existent profitable opportunities. However, the securities prices would absorb the information in a rapid pace and would reflect the fair prices, removing the profitable opportunities. Due to easy availability of the information, the organisations would not be able to trick the investors and thus lose on profitable financing prospects with positive NPV. Finally, the buying and selling in an efficient market would be based on the fair prices of the securities that offer no advantage to any of the players in it. Reference Brealey, A., R. & Myers, S. Financing and Risk Management. USA: McGraw Hill, 2003. Chuvakin, N. No Date. Efficient Market Hypothesis And Behavioral Finance – Is A Compromise In Sight? [Pdf]. Available at: http://ncbase.com/papers/EMH-BF.pdf [Accessed on April 18, 2010]. Pearsoned. No Date. Capital markets, market efficiency and ratio analysis. [Pdf]. Available at:ftp://ftp.pearsoned-ema.com/HPE_Samples/SampleChapters/9780273706441.pdf [Accessed on April 18, 2010]. Simon Fraser University. 2010. Intro to Corporate Financing and Efficient Markets. [Pdf]. Available at:http://www.sfu.ca/~awv/413/413l8ch14.pdf [Accessed on April 18, 2010]. Sloan School of Management. 2003. Market Efficiency. [Pdf]. Available at:http://ocw.mit.edu/NR/rdonlyres/Sloan-School-of-Management/15-433InvestmentsSpring2003/053C5622-671B-43C7-A828-A22E563FD7FC/0/1543322marketefficiency.pdf [Accessed on April 18, 2010]. Read More