Financial markets refer to established mechanisms that facilitate the trading of financial securities. Financial securities include bonds, shares, and debentures common stocks among others. Financial markets are classified into different sub-types each performing specific functions (Keown, Martin, Petty, & Scott, 2005). Examples are foreign exchange markets, stock markets, bond markets etc. Financial markets aid in distribution of economy’s wealth through exchange services that take place in them. The different investors are able to invest their funds through shares, bonds and other financial securities thus financial markets play a key role in economic growth and development. Financial markets provide an avenue through which borrowers find lenders interact in exchange for various services. Financial market like stock exchange allows one to sell or buy shares at will as long as the legal requirements are met. An economy would not operate without financial markets since exchange of goods and services and movement of other financial services would be impossible.
Distinction between Money and Capital Markets
Money markets are subsidiaries of financial markets that facilitate the trading of financial instruments that are highly liquid and short-term. It is used as an avenue for short-term borrowing and lending. Usually the securities used are less than a year. On the other hand, capital markets are subsidiaries of financial markets that facilitate the trading of long-term securities. They consist of bond and stock markets. The securities involved in capital markets are those with longer periods of more than one year (Keown, Martin, Petty, & Scott, 2005).
Major benefits enjoyed by Corporations and investors due to existence of Organized Security Exchanges
Security exchanges facilitate the selling and buying of shares between the investors and corporations. One major source of finance for corporations is through the sale of shares. The shares are listed in exchange markets regulated by relevant authorities to ensure their smooth running and guarantee investor confidence. Organized security exchanges guarantee returns and therefore investors are more than willing to devote their funds without any fear. In addition, corporations are able to raise their required capital through the issuance of shares since increased investor confidence lead to increased demand for shares (Keown, Martin, Petty, & Scott, 2005).
Calculation of Break-even point in units of output
Break-even in sales refers to a point where the total costs of production equals the total revenue of a firm. Several calculations are involved in break-even analysis.
Calculation of break-even in units:
= Fixed expenses ÷ contribution margin
Operating profit = 25 % of $ 20 million,
= 5 million,
Contribution = 15 million
Operating asset turn over = 5 times, therefore,
Variable costs =15÷ 5 = $ 3 million,
Fixed costs = 15-3= $12,
Break-even point in units = 12÷ 3,
= 4 million units.
To determine the break-even in units, the following formula is preferred.
Average Annual Fixed Cost ÷ (Average per Unit Sales Price – Average per Unit Variable Cost):
= 540,000 ÷ (180-126)
= 540,000 ÷ 54
= 10,000 units
Break-even in sales volume:
= Annual Fixed Cost ÷ 1 – (Average per Unit Variable Cost ÷ Average per Unit Sales Price)
= 540,000 ÷ 1- (126 ÷ 180)
= 540,000 ÷ (1- 0.7)
= 540,000 ÷ 0.3
= $ 1,800,000
The firm’s profit/loss when the following units are produced:
- 12,000 units
- Profit/loss = Total revenue- Total costs,
- Total revenue = price per unit× total units produced
- Total revenue = Fixed costs + total variable costs
Therefore at 12,000 units:
Profit = 12,000 × 180 – (540,000 + 126×12,000),
= $ 2,160,000 – (540,000+ 1,512,000)
= $ 2,160,000 – 2,052,000
= $ 108,000 (profit).
15,000 units
= 15,000 × 180 – (540,000 + 126×15,000),
=$ 2,700,000 – (540,000 + 1,890,000),
=$ 2,700,000 – 2,430,000
= $270,000 (profit)
20,000 units
= 20,000 × 180 – (540,000 + 126×20,000),
= 3,600,000 – (540,000 + 2,520,000),
= 3,600,000 – 3,060,000,
= $ 540,000 (profit).
- Degree of operating leverage (DOL) = Contribution margin ÷ Net operating income (NOI)
- Contribution margin = Sales – variable costs,
- Operating income = profits,
12,000 units,
= $ 2,160,000 – 1,512,000 = 648,000 (contribution margin),
NOI = $108,000,
DOL = 648,000 ÷ 108,000,
= 6 times
15,000 units,
= $2,700,000 – 1,890,000 = $810,000 (contribution margin),
NOI = $270,000
=DOL = 810,000 ÷ 270,000,
= 3 times.
20,000 units,
= $3,600,000 – 2,520,000 = $1,080,000 (contribution margin),
NOI = $540,000,
DOL = 1,080,000 ÷ 540,000,
= 2 times.
References
Keown, A. J., Martin, J. D., Petty, J. W., & Scott, D. F. (2005). Financial management: principles and applications. 10 Edn. New York, NY: Pearson Prentice Hall.