Financial Management Foundations Essay Example | Topics and Well Written Essays - 1500 words

Financial Management Foundations - Essay Example (Garcia-Terul and Martinez-Solano, 2000: p. 164). Investments in working capital constitute a tradeoff between risk and profitability because decisions that increase profitability also increase risk and vice versa. This is obvious even in capital markets where a tradeoff exists between risk and profitability. For example, investments in equities tend to be riskier than investments in savings accounts and bonds but equities tend to pay higher returns that savings accounts and bonds. (Bodie et al, 2005). A company that has a negative net working capital therefore faces higher risks than a company that has a positive net working capital irrespective of the profitability of the company. This is so because, the company with higher current liabilities may have high levels of debts that may be uncollectible, but which must have been included in the sales figure used in calculating profit. Debtors may default on the payment of debt and inventories may go obsolete. Finance literature has long recognized that market imperfection and information asymmetry affect finance. Thus, corporations must choose from the various financing options appropriate for them. These include, warrants issuance, derivatives instruments, common stocks and Preferred stocks etc. (Ambarish, John &Williams 1987). The purpose of this paper is to differentiate between the various financing securities and derivatives instruments. The remainder of the paper is organized as follows. Section 2 describes the various financial securities. In Section 3, differences e different financing securities are highlighted. Section 4 comments on the result and presents te conclusion. 2.0 Forms of Financing Securities Securities are often referred to as fungible, negotiable instrument representing financial values (Bodie, Kane, Marcus 2005). These instruments are broadly classified into debts securities (e.g., banknotes, bonds and debentures), and equity securities for example common stocks (Ross,Westerfield & Jaffe 1999). According to DeAngelo DeAngelo & Stulzb (2006) company or other entity issuing the security is called the issuer. What specifically qualifies as a security is dependent on the regulatory structure in a country. For example private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions (Ross, Westerfield & Jaffe 1999). Issuers include individuals, commercial banks, mortgage institutions and other international institution like the World bank. 2.1 Common stocks A common stock is an example of equity security. It represents the principal capital stock of a company. In most cases, Brealey & Myers (2005) state that a common stock security is a share in the capital stock of