Financial Management and Risks

Viktorija Semjonova EBS4

FINANCIAL MANAGEMENT AND RISKS

1. Profit maximization, by its name, tell us that the profit of the organization should be increased and is necessary for the survival and growth of the enterprise. While Wealth maximization relates to accelerate wealth of entity. Profit maximization is an aim of each company because the profit is a measure of efficiency, but Wealth maximization is same important because it increases and improves the market value of the shares. Profit maximization is a short-term objective of the firm while the long-term objective is Wealth maximization. Profit maximization ignores risk and uncertainty. Unlike Wealth maximization, which considers both.

Profit is the basic requirement of any entity. Otherwise, it will lose its capital and cannot be able to survive in the long run. But it is known that profit relates to the risk, and the higher the profit, the higher the risk. So, for gaining the larger amount of profit a finance manager should take such decision which will give a boost to the profitability of the enterprise.

In short run, finance manager can neglect the risk factor, but in long-term it cannot be ignored. Shareholders are investing money with hope of getting good return, so if the company do nothing to increase their wealth, shareholders will invest somewhere else and this king of finance manager's decisions may lead to the bad reputation of the company and fall of the market value of the shares.

1. The risk-return trade- off is the principle that potential return rises with an increase in risk. If the level of risk is low, then potential returns are low, and vice versa, if level of risk is high, potential returns are high.  It means that invested money can bring higher profit only if investor is willing to accept the possibility of losses.  In short-run, the return on stocks may be less or even negative but in the long-run the return on stocks is higher while the return on bond is stable but lower.
2. We focus on cash flows rather than accounting profits because these are the flows that the firm receives and can reinvest. The profit off the company may be higher but that include the non-cash profits, which cannot be spent. This is always incremental cash flows which have to be looked at, because the incremental cash flow is the cash available with or without making investments.  Also, we are only interested in these cash flows on an after tax basis as only those flows are available to the shareholder.

1. The market in which stock prices and other securities prices correctly reflect all the information available is known as efficient market. Efficient market hypothesis (EMH) states that it is not possible for an investor to outperform the market because all available information is already built into all stock prices. If the markets are efficient then all the release information will be correctly reflected in the stock prices of the company and it will be beneficial for the firm. Investors who agree with this statement tend to buy index funds that track overall market performance and are proponents of passive portfolio management.
2. Agency problem is the conflict of the interest between firm stockholders and managers. The agency problem arises due to an issue with incentives. An agent may be motivated to act in a manner that is not favorable for the principal if the agent is presented with an incentive to act in this way.

The main cause of agency problem is separation of management and ownership of firm. In some situations, it may happen that taking some decisions may be beneficial for the management but it may lead to losses for stockholders.

The agency problem can be solved by aligning the interest of shareholders and managers

1. Ethics are important in every industry, but nowhere as much as the financial industry, which connects all the people and businesses in an economy. Small and large financial businesses alike must behave ethically, for their own benefit, for their customers’ benefit, and for the benefit of the economy as a whole. Ethics in finance means establishing boundaries that prevent professional and personal interests from appearing to conflict with the interest of the employer. A finance manager must provide competent, accurate and timely information that fairly presents any potential disclosure issues, such as legal ramifications. The manager is also ethically responsible for protecting the confidentiality of the employer and staying within the boundaries of law.