Importance of Market Prices
Market prices are important as they reflect the market perception by the investors concerning the future prospects of the company. The market prices of stocks are affected by the economic conditions that are prevailing in the industry, the market perception and the events going in the company which are communicated in the media. The finance manager at times has to raise money in the market through the issue of shares. High market prices show that the company will be able to raise the targeted amount or even more when the people oversubscribe to the shares. It also shows that when the company issues bonds in the market the market will be receptive.
The finance manager has to use valuation principles to determine the value of the company’s securities. This helps in knowing whether the company know whether the securities such as stock are overpriced or underpriced. It also helps the company estimate the price at which the company should issue its shares at in the market. It also helps the managers determine the value or price of the securities at certain times in the future (Fabbozi, 1998, 13).
Net Present Value
conducting a cost benefit analysis. A cost benefit analysis is carried out by businesses to ascertain whether a certain business is viable or not. The only projects undertaken are those where the benefits outweigh the costs (Eugene & Ehrhardt, 2010, 383).
Interest Rates and Prices
The interest rate of a loan or bond can be considered to be a price. First of all when one takes a loan facility, the bank charges them a certain interest rate in order to access the money. It is therefore the cost or price of the loan. Similarly, if an individual places money in a fixed deposit in a bank, the bank will have to pay the individual interest at the prevailing rates in the money. It is the price or cost the financial institution incurs for using the public’s funds. The price of any item is determined by the supply and demand forces in the market. The interest rates similarly are determined by the market forces in the industry. When many people are applying for loans the interest rates may go up since the bank has limited funds. Lower interest rates encourage the people to take more loans.
Bonds and Loans
A bond is a loan that a financial entity has undertaken. It is a debt. It is a security issued to the public where the financial entity is obligated to pay yearly interest at certain for a number of years till the maturity date of the bond. At the maturity date, the company will pay the principle amount. It is similar to a loan facility in several ways. A company will approach a financial institution and borrow a certain amount of money to pay in equal instalments over a certain period of time. The loan is given at a certain interest rate. As one pays the monthly instalment one pays certain amounts of both the interest and principal elements. The bond and loan require the financial entity to pay interest at a certain rate for the duration of the facility. At the end of the period, the company will have paid the interest and the principle amounts.
Eugene, B. & Ehrhardt, M. (2010). Financial Management Theory and Practice.
United : Harcout College Publishers.
Fabbozi, F. (1998). Valuation of fixed income securities and derivatives. Canada:
John Wiley and Sons.