Rate of return, risk, liquidity

Rate of return, risk, liquidity Rate of return, risk, liquidity

Every investment bears a certain risk that our expectations, usually an expectation of a certain profit, will not be fulfilled. Investment is an exchange of guaranteed current value for expected higher future value. Investment functions to maximize investor’s profit. While investing it is necessary to respect a lot of theoretical knowledge that can limit the risk considerably. While investing we take into consideration especially the rate of return, risk and liquidity.

Rate of returnRate of return expected rate of return is one of the

major criteria that the investors take into consideration while contemplating the choice of their investment. The rate of return is usually showed in percents and represents the ratio between invested resources and resources gained from the investment.

Return is a sum of all earnings and incomes from the realized investment expressed in monetary units.

RiskRiskInseparable part of any investment

is a risk. Risk can be described as a degree of uncertainty connected with the expected return. It is always necessary to establish exactly the type of risk involved and specify it.

LiquidityLiquidityit is a velocity with which the owner

is able to change his investment into cash with the lowest loss. While considering an investment there is a principle that in a case of more alternatives with the same degree of risk and the rate of returns the investor prefers an investment that has higher liquidity.

Magic triangleMagic triangle

The ideal idea of an investment from the investor’s point of view is the one that has the highest liquidity, minimal risk and highest rate of return. Such an optimal investment does not exist in real life, on contrary it is true that the less risk the investment carries the lower liquidity and rate of return it has.

Magic triangleMagic triangle

All investments carried out through the financial market move inside the magic triangle, where the tops connect one another. That represents the fact that revenue, risk and liquidity do not exist separately. The magic triangle shows how the three affect each other.

PortfolioPortfolioPortfolio is represented by combination

of financial or real assets. The main advantages of creating a portfolio are a diversification of risk and very mild adaptation to the requirements of the investor. By creating a suitable combination it is possible to establish a very effective investment that in case of unexpected decrease of revenue from one of the assets will be leveled out by increase of revenue of another active that is a part of the portfolio. This is a way how to lower the risk by quite a lot.

While creating a portfolio the choice of assets is crucial. The main emphasis is on nearness of assets. When investing into insurance companies in one country, the risk is spread but when a crisis of the whole sector occurs then all the invested means are influenced negatively.

for example a natural disaster in the country that means payment of large sums from the insurance contracts

Concentration of capitalConcentration of capital

Nowadays the trend is a formation of large investment configurations that are established in order to invest effectively. Huge multinational corporations are very often these investors. As a result of very fast technological development in the area of information technologies a better possibility of market expansion into markets that had not been reachable has become possible. These multinational corporations try to penetrate into markets that are convenient for them strategically, due to low competitiveness, lower costs or expected high revenues and often use negotiations at the government level when trying to enter the market.

The fundamental law of a company’s influence in the market is to provide goods or services that we are able to produce with minimal costs so that after deducting all costs from the sale price the company makes a profit. Multinational company can afford to set the price of goods lower then the market price due to large cost savings of costs of production as a result of large amounts of products and still make profit. That makes the competitors to lower their price and that creates strong competitive pressures.

Kind of AssociationKind of AssociationAssociation based on a contract

Association based on a capital interconnection

Association based on a Association based on a contractcontractA frequent type of an association of two or more companies is a cooperation based on an agreement with the aim to pursue collective interests. The participants of such an association keep their legal independence and in most of the cases also keep their economic independence.

Strategic alianceConcernSyndicateCartelFranchisingJoint - venture

Strategic allianceStrategic allianceA frequent type of an association of two or more companies is a cooperation based on an agreement with the aim to pursue collective interests. The participants of such an association keep their legal independence and in most of the cases also keep their economic independence.Example: The Lite-on and BenQ companies created strategic aliances to product Blue ray devices. Normaly are Lite-on and BenQ concurents. Lite-on bring ours technologies and BenQ ours trade canals and money.

ConcernConcernIt is an association of legally

independent companies that are governed by a collective management. As a whole the association does not possess legal identity and it is an interconnection of companies that are not connected by capital.

Example: Concern VW connecting Audi, Seat, Škoda and VW auto producers.

SyndicateSyndicateIt is an association of more subjects in

order to carry out a project that overlaps the possibilities of an individual subject or possibly the risk is too high for one subject. It is often used by financial institutions when financing very costly and risky projects when as a result of risk diversification the risk is spread over more subjects. Clasical example is syndicate of banks which financing very large project and for one bank is this project very riskant.

The „syndicate“ term is offen used for trade union. For example syndicate of artists, syndicate of journalists.

CartelCartelIt is a contractual agreement of a

subject to abide agreed conditions when conducting this business activity. Most common is the case when companies that produce the same or similar products join together in order to prevent competition. Depending on the field of work cartels can be divided into:◦ Production cartel – the subject agree to

standardization, specialization and unification

◦ Distribution cartel – the most well-known kind is a price cartel, when the subjects agree on a price. It is very dangerous in relation to the harm of price mechanism in an imperfect competition on a market

Cartel OPECCartel OPECProbably the best known is petroleum cartel OPEC-

Organization of the Petroleum Exporting Countries Which is an organization that associates 11

petroleum exporting countries. Main activity of OPEC is to coordinate petroleum exploitation and negotiations with petroleum companies about amount and price. Nowadays OPEC controls about 75 % of the world’s petroleum reserves and provides a third of the whole petroleum production. Mainly in the times of high petroleum price fluctuations as a result of natural disasters or wars OPEC decisions greatly influences the petroleum price in the world’s market.

FranchisingFranchising

It is the contractual providing of the business name, symbol, logo, trade mark or other business or intellectual property, know-how, economical and technological methods for direct or indirect payment.

This type of financing was established in America in the 19th century when it was the company Singer that produces sewing machines who started to use it first.

In the 1950`s franchising took its current shape thanks to companies such as McDonald’s and Holliday In. Mainly due to these two companies franchising endured and started to be used in other areas. The most applied form is in the catering industry and fast food has gradually taken over hotel chains, estate agent businesses, electronics and fuel sale.

 The franchising provider is usually a

company that is successful in its working field and it offers its knowledge to another subject for a so called franchising fee. The limit of the fee unwinds for the fruitfulness of the company and mainly from the expected profit.

Joint - venture Joint - venture Two more legally and economically independent

companies create another company in which they share all laws of property. The main aim of such a creation is to finance activities together that will be useful to all the participants. Joint venture is very often used as a mean of entrance for capital onto foreign markets. The great advantage is the contribution with new technologies and business practices of foreign joint venture partners. The domestic companies bring in knowledge of the business environment and are also already established in the local business sector. Classical example of joint venture in the Czech republic are car companies such as Toyota, Citroen, Peugeot that built together a manufacturing company to produce their cars in Kolin. This form of interconnection is also very often used in research and development.

ExampleExampleThe Dow Chemical Company

(Dow) and Petrochemical Industries Company (PIC) of the State of Kuwait, a wholly owned subsidiary of Kuwait Petroleum Corporation (KPC), today announced plans to form a 50/50 joint venture that will be a market-leading, global petrochemicals company.

Associations based on Associations based on capital interconnection capital interconnection

It is a very stable interconnection on the contrary to connections only based on contracts.◦Holding◦Merger

HoldingHoldingIt is a holding control of a company

through the buy out of the necessary amount of shares. The company that holds the shares is called a controlling company. The controlled company is called subsidiary company. Legally these two are totally separate and in case of a business loss of one of the two it is not transferred onto the other. In real life holding has many forms:◦Pyramid structure of holding◦Radial structure of holding◦Cyclical structure of holding

Pyramid structure of Pyramid structure of holdingholdingPyramid structure of holding represents

a way how to overmaster with relatively small amount of capital a great amount of companies. The Controlling Company on the first level controllers the subsidiary companies on the second level. Every subsidiary company on the second level controls subsidiary companies on the third level. The controlling company can control all its subsidiary companies in this way without having any capital participation in them.

Pyramid structure of Pyramid structure of holdingholding

Radial structure of holding

The controlling company has the necessary participation in capital in all its subsidiary companies. Such a structure is more demanding on the amount of capital needed to control a higher amount of companies than in case of the pyramid structure.

Cyclical structure of Cyclical structure of holdingholding

In this type of structure it is not possible to establish without doubt which company is the controlling company and which company is the subsidiary company. It is a closed circle of capital interconnection. In real life there are most frequent combinations of all above mentioned types. Pyramid, radial and cyclical are only basic types.

MergerMerger

Merger means connection of two or more companies with separate legal identity into one company. This process can be divided into two possibilities:◦Mergers◦Acquisitions

Distinction between Distinction between Mergers and AcquisitionsMergers and Acquisitions Although they are often uttered in the same breath

and used as though they were synonymous, the terms merger and acquisition mean slightly different things.

When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.

Market protection Market protection In case that there happens to be

such a capital concentration that the other companies in the market segment stop being able to be competitive it is then necessary to create such a legal environment that would prevent this. This is a result of several motives.

Support of allocation affectivity of companies – the company is able to use its resources better when it is forced to lower its costs by strong competition

Never-ending innovation – with the fast development of new technologies is connected their easy usage and its very fast implementation into production and towards the customer. In case of a monopoly the company is not forced anyhow to invest into new technologies, research and development and as a final effect the customer starts to feel that the standard of products and services is not getting better.

Price reduction – in case of a monopoly the price is set by the producer, in case of perfect competition there is an effort to lower the price so as to attract as many customers as possible.

Dynamic adaptation to the requirements of the customer - companies that operate in perfect competition have to constantly adopt to the customers` requirements and on the contrary in case of monopoly the customer haze to adapt to what the monopoly offers.

MonopolyMonopolyExistence of monopoly can have

several reasons and it is not appropriate to disapprove of it.◦Formation of a monopoly through trying to be best in the field

◦Formation of natural monopoly established by the state

Market protection against Market protection against imperfect competitionimperfect competitionLegal market protection against the negative

influence of a monopoly on the market was established in the 19th century in the USA by accepting Sherman’s Act. During the 20th century market protection against trust contracts and especially their price form that is by now forbidden in most countries was established. Since the beginning of creation of the legal system there have been battles among supporters of the antimonopoly precautions and free market supporters that opposed of antimonopoly precautions are the punishment for success. From the very beginning anti-monopoly laws have been broken many a time. Great role in their gradual adaptation to the market conditions also had the logging and intentness of people that were working on these laws.

The main object of these precautions is to restrict the amount of advantages that the subjects operating on the free market can gain against their competition. Antimonopoly laws set rules for free market regulations and strictly penalize some forms of competition like e.g. joining of companies in order to exceed the enabled cut-in in the market, setting too low or too high prices, price contracts to the determinant of customers.

Foreign investmentForeign investmentWhile making decisions about placing free

financial resources one of the possibilities it to invest into an already existing company abroad. In case that we achieve such a share that we can influence the company management we call such a transaction direct foreign investment.

In the world it is called the direct foreign investment in case that the institution holds the minimum of 10% equity shares or voting rights. Other definitions are only a little different especially in setting the amount of minimal share. Every company that wants to influence and completely control another company must have a share of 51%.

Advantages of direct Advantages of direct foreign investmentforeign investment

Direct foreign investment brings a great amount of advantages for the investing company that contribute as a side affect to the investors grow and gaining access to foreign technologies, experts, distribution channels, trade-mark, licenses, know-how and similar. Quite often such an investment leads to expanding the current production programmed and offering of new products or we gain access to new markets that have been unreachable up to now. Economically it mainly means better capacity utilization, cost savings and adequate capital yield from invested resources.

Risks of foreign Risks of foreign investmentinvestment

The biggest risk results from the political situation in the country into which the company intends to invest its resources. Among the factors that influence the risk are government stability, law enforcement, inflation rate, gross domestic and foreign product growth, height of tax payments, influence of economy by the government and central bank, swaying of exchange rate and others. The risk can be lowered by creating a diversified portfolio in this way:◦ Purchase of securities of international funds◦ Purchase of securities in international markets◦ Purchase of shares of foreign companies in the

domestic market ◦ Investment into securities of multinational

companies  

Protection against riskProtection against risk

The company when judging international investment has to follow the exchange rate movements and has to decide whether it will adopt steps to lower the risks of exchange rate movements. Ordinarily there are two types of minimalizing risks – external and internal.

InternalInternal protection protectionLagging - in the case we expect a

growth of the domestic currency we try to fulfill all the foreign payments as late as possible.

Leading – the opposite, it we expect a fall in domestic currency we try to pay all our payments as soon as possible

Netting – it is a mutual credit of obligations and demands in one company with branches in more countries in one currency

Matching – it is a many-sided credit of obligations and demands in one currency

Offshore companiesOffshore companies At the beginning of the 1980´s it was possible to follow an

interesting trend when important financial companies, banks and insurance companies started to establish their branches or move their companies into so called „tax paradises“ such as the Bahamas, Hong Kong, Seychelles and Belize out of the classical financial centers such as London and New York. The main reason was lower tax payments, which rate differs with the destination but does not exceed 20%. The incomes from foreign activities are in most of the countries tax free. Another advantage is thorough keeping of bank secrecy and creation of legal environment that facilitates the establishment of companies and lowers administration costs. Due to the development of information technology it also leads to a limitation of the distance effect created by the clients distance when the account access is secured by the immediate internet access and all electronic correspondence is pointed to any connected computer around the world.

  Nowadays about 46 out of 50 world top banks have their

branch in „tax paradises“ and in the top 10 world financial centers there are countries such as Hong Kong, Cayman islands and Bahamas.