Markets facilitate all this transaction process. Most of the times, the Individuals are investors, who invest their excess capital into the markets to earn the return. Several different factors play a role for individual making investments. Some of the factors include risk, current market conditions and competition among others. Markets are the last player in this whole process and these are the places where buyers and sellers connect to each other to make business transactions and the markets can be local, regional or international depending on the economy.
Declines or Inclines can be seen In the markets depending upon the overall economic conditions for example ND decline occurs if the market is saturated with goods and services due to lack of demand and market slows down. The implementation of the finance operations task is to arrange for financial assistance and guidance, support of the obtaining process, providing pay support, and providing distributing support.
Financial experts continue to expand beyond their traditional role of concentration on transaction processing and financial reporting to providing tactical supervision to corporations, There are various different types of finance companies, which are mentioned as follows. Types of Finance Companies: Finance companies have more than $1 trillion in assets and some of them are independently owned while others are subsidiaries of financial Institutions and corporations. There are many large companies that are subsidiaries of American Express, General Motors, Citreous, and General Electric.
Categorization of these finance companies depends on the specific service that they offer. Consumer Finance Companies: These companies provide financing for customers of retail stores and whole-sealers. For example, a customer finance company can sponsor a credit card to the retailer so that the retailer can offer its own credit card to its customers. This whole process facilitates the customers to make purchases on the credit and make payment later to the retailer. There are some fiance companies that provide direct loan to the consumers to make big purchases for their house hold use.
As the names state that the business finance companies offer loans to small businesses. The businesses use those loans to make further purchases to use in production of goods and buying more inventories. Once the items are manufactured and sold by the businesses then these businesses return the amount of loan back to these companies with some interest. Business finance companies also provide financing to other companies so that these companies are able to give credit cards to their employees to make purchases behalf of the company.
Captive Finance Subsidiaries (CIFS): The number of CIFS grew more rapidly between 1946 to 1960 as a result of liberalized credit policies and a need to finance growing inventories. These are entirely owned subsidiaries whose primary function is to finance the parent company’s products and services, provide wholesale financing to distributors of the parent company’s products and they also purchase receivables of the parent many. There is a good example of automobile industry where the manufacturers were not able to finance dealer’s inventories and had to demand cash before the delivery of automobiles.
On the other hand the dealers were unable to sell the cars on installments because they needed cash immediately. The dealers used to rely on the banks for financing and the banks used to take automobiles as luxury items that are not suitable for banks financing. Banks were unwilling to buy installment plans created from automobile sales and that whole scenario led automobile manufacturer o get into financing to support their businesses. Sources to Acquire Funds: Finance companies use different means to acquire funds and they do not rely heavily on deposit.
On the other hand the commercial banks and saving institutions rely mostly on deposits. Finance companies have various different sources of funds that are as follows: Loan from banks Commercial paper Deposits Bonds Capital Private contracts Farm Credit Services Aggie Bond programs U. S. Department of Agriculture (USDA) Farm Service Agency (FSP) Loans from Banks: Commercial banks are one of the main sources for finance companies to obtain Finance companies also use these bank loans to accommodate seasonal swings in their business.
Commercial paper: When we talk about commercial paper the short term financing option comes in mind. Only well established companies are able to issue commercial papers and not all companies have ability to issue this debt, there is also chance of investment risk for investors if the commercial paper is unsecured. Recently the secured commercial papers have become more popular and more companies are going towards this option because a secured commercial paper is easy to issue as compare to an unsecured commercial paper. Companies have various options to issue commercial paper through.
Either the companies can use a dealer to issue commercial paper that is more expensive while on the other hand the companies can also issue commercial paper through direct placement. Deposits: Deposits have not been major source of funds for finance companies but still many companies use this option in the states where it is legal to obtain funds through deposits. There are many finance companies offering customer deposits similar to those of depository institutions. Bonds: Bonds are long-term debts issued by the finance companies to raise funds.
There are several different factors that are driving forces behind the finance companies to select among short term financing versus long term financing like bonds. The key factors that effect company’s decision are interest rates and the company’s balance sheet structure. If the interest rates will rise in the market than the finance companies consider using the funds obtained from bonds to offer loans with variable interest rates. If decline in interest rates is observed in the market, finance companies may use long-term debt to lock in the cost of funds over the extended period of time.
Capital: Capital is defined as financial assets or the financial value of the assets such as cash or machinery equipment owned by the company. Most finance companies usually tend to maintain a low level of capital percentage as compared to total assets. Capital base is build by issuing stock or by the company’s retained earnings. Public offerings of stock are issued when a company plans to expand its operations. It is very important to have enough capital for a company because it is the main financial resource for a company.
Private Contracts: In private contract there are many property owners who are willing to do direct entrants with a first time farmer for sale of land, machinery, or other resources. This arrangement can be based on the understanding of both parties. They can do cash deals to share rent to work-in arrangements in which labor pays for part or all of the property. Farm Credit Services mining & Beginning” Program: Such service offers a loans for less-established manufacturers who are in the range of age 35 or younger, or with 10 years experience or less.
These loans include real estate loans, operating loans, and insurance for the manufactures. They also have reimbursement program for business education and financial management lolls. Aggie Bond Programs: Aggie Bond Program is very similar to Farm Credit services; in which numerous states have designed a tax-free bond program to assist beginners acquire farmland, Consumer Loans: Consumer loans are the amount of money loaned out to individuals for personal use such as household and family needs. These are usually loaned on non-secured basis.
The most popular type of consumer loan is automobile loan usually offered by the finance company, which is usually owned by the car manufacturer. Many popular automobile companies such as Ford Motor Company and Chrysler own their own enhance companies and offer low interest rates to attract customers. Usually a co- signer is required for personal loans and they mature within five years. Consumer loans are monitored by government regulatory agencies for their compliance with consumer protection regulations and vary from state to state.
Finance companies sometimes offer credit card loans through retailers. What usually happens is retail store sells its products to customers on credit then they sell the contract to financial companies who are now in charged of processing payments and approvals. Business Loans and Leasing Business or commercial loans are loaned out to companies by financial institutions to purchase raw materials until cash is generated from the finished goods. These loans are usually short term but are renewed whenever companies need financing to support their cash cycles.
These loans are backed by accounts receivable and inventory on hand. Real estate Loans Real estate loans are offered by financial institutions in a form of mortgages for commercial real estate and second mortgages on homes. Second mortgages have the lowest default rates compared to other loans. The loan with the highest default rate s the supreme mortgage loan, which is a low quality mortgage loan. Risk Faced by Finance Companies Liquidity Risk Is the risk that’s comes from the lack of marketability of an investment that cannot be purchased or sold quickly to minimize or avoid losses.
The cause of liquidity risk is due to a company trying to trades is assets but nobody in the market wants to trade for that assets. Interest Rate Risk Liabilities and assets are both short and intermediate term for finance companies. Finance institutions are not as disposed to increasing interest rates like other saving establishment. Assets of finance companies are not as rate sensitive as their liabilities. Reduction in the interest rate risk results in in shortens asset life.
Credit Risk For all the finance companies the credit risk is very important factor because majority of their funds are allocated as loans to consumers and businesses. Usually there is involvement of moderate degree of risk in terms of consumers borrowing from finance companies. The ratio of consumers to repay the loans back to financial companies is lower than other lending institutions. The performance of finance impasses can be quite sensitive to prevailing economic conditions because their loans require both high risk and returns.
Valuation of Finance Companies: Finance companies are supervised and monitored by their managers on periodic basis to check their progress. There is also involvement of other financial institutions who cross check the health of these finance companies regarding acquisitions and present value of their future cash flows. Required rate of return by investors and present value of future cash flows plays a vital role in determining the financial health of these finance companies. Factors That Affect Cash Flows Following is the model of change in company’s expected cash flows.
The worth of finance companies and the loan repayments are eve sensitive to economic conditions because of relatively risky loans offered by finance companies. Change in the Risk-Free Interest Rates If the interest rates goes up so the finance company’s cash flows go down because there is a inverse relation between both of these. If the market observes a decline in the risk free interest rates and the other market rates also goes down so the demand for the loans from the finance companies increases. Rates on the short-term funds are revised by other company’s offerings.
The consumer loans borrowed by finance companies usually have fixed rates so that until those assets reach to the maturity level, they does not get adjust to the interest rate movements. Fall in the interest rates results in the decline of the cost of obtaining funds more then the decline in the interest earned on its loans. There is the reduction in cash flows of the finance companies, if there is increase in interest rates, because the interest paid on its sources of funds increases, but it does not affect the existing loans and investments of a finance company. Change in Industry Conditions
Regulatory constraints, technology and competition with in the industry come under the industry conditions. Some finance companies are privileged enough to the opportunity given by the state representatives to generate economies of scale by expending through out the state. These kinds of finance companies are valued more because of the privilege of being backed by the state. This increases the competition because some finance companies gain at the expense of others. Change in Management Abilities Like other companies the finance company has control over the structure of its management and organization.
There are many external forces that are beyond control of the management of these finance companies, such as economic growth, regulatory constraints and interest rates. However the cash flows of these finance companies can be influence by the management skills of managers. All the finance are in need of skilled managers who posses the ability to analyze the creditworthiness of potential borrowers and they can also predict the future economic conditions that may affect their ability to repay the loans.
Factors that Affect the Required Rate of Return The require rate of return by investors who invest in the finance company is as Where ARP represents a change in the risk free interest rates, and ARP represent a change in the risk premium. For economic growth and the budget deficit level the risk free interest rates normally expected to be positive in relation to inflation, inversely related to money supply growth, because there is a inverse relation between the economic growth and risk premium.
Skills of the financial managers reduces the exposures of the company to the risk if the managers are more skillful then there is a chance of less risk to the company. It means that the Rick premium is inversely related to the company’s management skills. Interaction with other Financial Institutions There is an interaction of finance companies with their subsidiaries and other financial institutions. Finance companies mostly work in the area of consumer lending so that they are closely related to savings institutions, commercial banks and credit unions.
There are some finance companies with subsidiaries that specialize in other financial companies compete with insurance companies and pension plans. There is a competition between finance companies and saving institutions in the area f consumer financing, and if the saving institutions face any problems then it becomes the opportunity for finance companies to recruit more customers and gain a big market share. Some of the finance companies have acquired saving institutions such as Household International Inc.
Participation In Financial Markets Finance companies use different financial markets to complete their operations. Mainly they obtain funds by utilization of financial markets, their also subsidiaries of finance companies that utilize financial markets to invest funds and also to hedge investment portfolios against interest rate risk. There are some finance companies that diversify through international expansion so that they are able to use international bond and commercial paper markets as a source of funds.
In the past some finance companies have acquired insurance companies to enter in the insurance business. Not only the insurance companies but they also have acquired some commercial banks located in different states. There’s a history of larger financial companies entering into non-financial businesses for the sake of diversification. This diversification helps the companies to reduce the risk and increase the returns.
