Financial Decision Making Discussion

ANSWERED

Given your understanding of how financial decisions are made in either for-profit or non-profit firms, choose a specific firm as a basis for your posts.

• What are the linkages among financial decisions, return, risk and stock value for this firm?
• Why are these linkages important?
• How does the financial manager incorporate these as s/he manages the assets and liabilities of the firm?
• How can stockholders know that these linkages are being managed well?
• How might these linkages differ in different industries?

ANSWER

Discussion Essay

What are the linkages among this firm’s financial decisions, return, risk, and stock value?

There is a positive relationship between risk and returns. The risk-reward tradeoff principle postulates that low-risk levels will result in low returns and high risks in high returns (Ghysels et al., 2005). Financial decisions often involve managing risks by calculating their overall risk tolerance to determine whether or not to invest. Any decision a financial manager makes can affect the risk/expected return of the company’s stocks, both of which comprise the stock valuation model.

Why are these linkages important?

These linkages are essential because they help in stock valuations. Stock valuation refers to the quantitative evaluation of a company’s value and its stock value. These valuations are used in making decisions related to asset/liability management.

How does the financial manager incorporate these as s/he manages the assets and liabilities of the firm?

The primary goal of a financial manager is to maximize a firm’s value to its owners. To do this, the financial manager must conduct asset/liability management which involves managing assets (stocks) and cash flow utilization to reduce a firm’s risk of loss.

How can stockholders know that these linkages are being managed well?

Stockholders can use many key performance indicators to determine whether the linkages are being managed well. These performance indicators include the firm’s financial performance, earnings, dividends, and share prices.

How might these linkages differ in different industries?

There is a causal relationship between industry returns and stock market returns, but these relationships differ depending on industry and country. According to Lee et al. (2013), industry returns have a unidirectional leading effect on market returns in the oil and gas industry in Thailand, consumer services in Japan, Malaysia, and India, and basic materials in China. This study implies that the relationship between return, risks, and stock value depends on the country and industry to which a firm belongs. For example, the pharmaceutical and healthcare industry benefit more when risks are minimized as much as possible.

References

Lee, C.-C., Chen, M.-P., & Chang, C.-H. (2013). Dynamic relationships between industry returns and stock market returns. The North American Journal of Economics and Finance, 26, 119–144. https://doi.org/10.1016/j.najef.2013.08.002

Ghysels, E., Santa-Clara, P., & Valkanov, R. (2005). There is a risk-return trade-off after

all. Journal of financial economics, 76(3), 509-548.