Capital

Read the text and be ready to speak on:

1. The funds the capital of a business consists of;

2. the classification of capital;

3. the types of financing.

The capital of a business consists of the funds used to start and run the business. The funds may be either the owner’s (equity capital) or creditor’s (debt capital). Equity capital consists of those funds provided to the business by the owner(s). These funds come from the personal savings of the owner. Debt capital consists of borrowed funds that the business owner owes to the lender. With debt capital the entrepreneur doesn’t have to share ownership, but has a legal obligation to repay the borrowed money (principal) plus interest at a future data even if the business does not make profit.

Capital is also classified, depending on it use, as fixed or working. Fixed capital refers to items bought once and used for a long period of time. These items include real estate, fixtures, equipment. With a grocery, for example, the real estate consists of the store itself and the land on which it is built. The fixtures include such objective as counters, refrigerators, shelves. Equipment covers such articles as cutting machines, knives, scales. Working capital refers to the funds used to keep a business working or operating. It pays for merchandise, inventory and operating expenses such as rent, utilities (light and heat), taxes, wages. Cash on hand and accounts receivable are also considered working capital. Therefore, working capital is cash, or anything that can easily and quickly be turned into cash.

Equity financing (obtaining owner funds) can be exemplified by the sale of corporate stock. In this type of transaction, the corporation sells units of ownership known as shares of stock. Each share entitles purchaser to a certain amount of ownership. For example, if someone buys 100 shares of stock from Ford Motor Company, that person has purchased 100 shares worth of Ford resources, material, plants, production and profits. The person who purchases shares of stock is known as a stockholder or shareholder.

All corporations, regardless of their size, receive their starting capital from issuing and selling shares of stock. The initial sales involve some risk on the part of the buyers because corporation has no record of performance. If the corporation is successful, the stockholder may profit through increased valuation of the shares of stock, as well as by receiving dividends. Dividends are proportional amounts of profit usually paid quarterly to stockholders. However, if the corporation is not successful, the stockholder may take losses on the initial stock investment.

Often equity financing does not provide the corporation with enough capital and it must turn to debt financing, or borrowing funds. One example of debts financing is the sale of corporate bonds. In this type of agreement, the corporation borrows money from investor in return for bond. The bond has maturity date, a deadline when the corporation must repay all of the money it has borrowed. The corporation must also make periodic interest payment to the bondholder during the time the money is borrowed. If these obligations are not met, the corporation can be forced to sell its assets in order to make payments to the bondholders.

All businesses need financial support. Equity financing (as in the sale of stock) and debt financing (as in the sale of bonds) provide important means by which a corporation may obtain its capital.

T E X T 4

Read the text. Define the main idea of each paragraph. Underline the sentences expressing these ideas.

FINANCIAL MARKETS

Financial markets provide a forum in which suppliers of funds and demanders of loans and investments can transact business directly. Whereas the loans and investments of institutions are made without the direct knowledge of the suppliers of funds (savers), suppliers in the financial markets know where their funds are being lent or invested. The two key financial markets are the money market and the capital market. Transactions in short-term debt instruments, or marketable securities, take place in the money market. Long-term securities (bonds and stocks) are traded in the capital market.

The money market is created by a financial relationship between suppliers and demanders of short-term funds, which have maturities of one year or less. The money market exists because certain individuals, businesses, governments and financial institutions have temporarily idle funds that they wish to put in some type of liquid assets or short-term, interest-earning instruments. At the same time, other individuals, businesses, governments and financial institutions find themselves in need of seasonal or temporary financing. The money market thus brings together these suppliers and demanders of short-term liquid funds.

The capital market is a financial relationship created by a number of institutions and arrangements that allows the suppliers and demanders of long-term funds -- funds with maturities of more than one year – to make transactions. The backbone of the capital market is formed by the various securities exchanges that provide a forum for debt and equity transactions. Major securities traded in the capital market include bonds and both common and preferred stock.

All securities, whether in the money or capital markets, are initially issued in the primary market. This is the only market in which the corporate or government issuer is directly involved in the transaction and receives direct benefit from the issue – that is, the company actually receives the proceeds from the sale of securities. Once the security begins to trade among individuals, businesses, government or financial institutions, savers and investors, they become part of the secondary market. The primary market is the one in which «new» securities are sold; the secondary market can be viewed as an «issued» or «preowned» securities market.

During the last two decades the Euromarket – which provides for borrowing and lending currencies outside their country of origin – has grown quite rapidly. The Euromarket provides multinational companies with an «external» opportunity to borrow or lend funds with the additional feature of less government regulation.

1. What is a financial market?

2. What are the two key financial markets?

3. In what do they differ?

4. Differentiate between primary and secondary markets.

T E X T 5

WHAT ARE DERIVATIVE INSTRUMENTS?

It may sound like a house of cards, but many financial instru­ments in the global economy are based on nothing more than the value of other financial instruments. Today it would be impossible to responsibly manage any significant international investment without an understanding of financial derivatives like options, financial futures, and interest rate swaps. A stock option, which allows an investor to purchase or sell a given stock at a fixed price sometime in the future, is called a derivative because its value is determined by the value of an underlying stock.

A financial future is an agreement to buy a financial instrument— such as a stock or bond—sometime in the future at a fixed price. A stock index future, for example, allows investors to benefit from the rise in a stock index by buying, in a sense, all the shares in the index. Just as a gold future goes up in value when gold's price rises, a future on the Standard & Poor's 500 will increase in value when the stock index rises.

The basic idea of a swap is to trade something you have for something you want. A swap is a trade agreement between two or more counterparties, usually banks, to exchange different assets or liabilities such as interest payments. Essentially, it allows both parties to obtain the right assets and cash flows for their own particular needs. In the case of banks, this most often means trading two loans with different interest rates or different foreign currencies. For example, a bank lending money to consumers at a fixed interest rate may be borrowing money at floating or periodically changing interest rates. In order to eliminate the risk of having borrowed and lent money at two different interest rates, the bank enters into an interest rate swap agreement with another institution to exchange one flow of interest rates for another.

1. What is ‘a financial instrument’?

2. What does a stock option allow?

3. What is ‘a financial future’?

4. What is the basic idea of a swap?

T E X T 6