Category: Economics 2707

Introduction

Transportation is integral as part of infrastructure to the economy of the nation as it is required for the numerous sectors of the economy to prosper. All the main sectors of the economy including the service sector, manufacturing industries and agriculture rely heavily on transportation. Its importance is further highlighted by its recognition as one of the main sectors of the economy, much of which can be attributed to its commercialization over the past few years. Developed countries have formed the basis of their development on improved infrastructure thus enabling substantial growth.

Rodrigue, Comtois and Slack (2006, pp. 83-84) document only too well the implications of efficiency and lack of it in transportation with a sort of conveyor belt of results from direct to indirect on the economy. They also point out that the constant evolution of the sector and subsequently the interlinking of various modes mean that modular transport has shaped economic growth rather than the advent of any particular individual mode.

1980-2000: National transportation

During the onset of this period the government completed the interstate highway connections (The National Atlas of the United States of America, 2009, para. 9) and this was subsequently followed by a vast increase in the ownership of vehicles. The highway connections increased the variety from which transporters could choose as to which mode they wanted to use. It was not just in road transport that the quality and reach of a mode was improving, this could also be seen in other modes like rail with faster speeds and also air transport with larger planes and increased reach in both.

Therefore, the effects of such national transportation had an effect on both inland and cross-border trade. As Rodrigue, Comtois and Slack (2006, pp. 89-90) note the increased interconnection has both negative and positive outcomes since they lead to specialization due to comparative advantages. The production of certain products decreased while others were bound to increase and as the United States Department of State (2009, para. 2) reports the 1982 oil crisis occasioning a drop in local production and a steep rise in consumption of imports.

Increasing levels of trade meant that the demand for transportation increased and in order to insure against losses arising from ineffective and congested modes of transport, the public and private sectors sought to try and increase mobility. By foreseeing increased demand, especially after the recession of the early 1980s, some investors were able to invest by lending money to the government as infrastructure bonds while others used the opportunity to commercialize and gain from transportation.

Costs incurred due to capacity building of the sector contributed to the escalation of the budget deficit as more money was sought to finance the growth of the sector mainly through the bonds (Federal Reserve Bank of San Francisco, 2000, para. 4). The reliability of such avenues as roads meant that growth in terms of usage of trucks to transport especially small-scale cargo gained prominence. Courier firms with the specialized nature of their deliveries expanded their reach to become national and also international. This is because of the requirements of delivery of goods and also the distance of travel of the goods being large or intercontinental thus requiring air transport.

The period witnessed vast growth in the airline industry as it became progressively cheaper and more convenient to travel long distances by air. In terms of passengers, many opted to switch from buses and rail to the airlines over long distances. As a result many of the airports were upgraded and some were also built a new in view of the stage of development of the mode from expansion and standardization to integration as illustrated by Rodrigue, Comtois and Slack (2006, p. 95). Thus they were also interconnected with other modes like road and rail, especially the subway due to their locations that remain mostly centralized.

The growth of the airline industry served up to decrease the volume of road transport for use in the ferrying of other freight thereby decreasing congestion and increasing the popularity of air travel necessitating for its rapid expansion by the entry into the market by more providers. This was also mainly due to the deregulation of the industry in 1978 which freed it from government control allowing market forces to shape the business as observed by Stanford Education(2005, para.14-18). Due to the growing use of the airport, it also became a hub of vehicles for the loading and offloading of cargo. These mostly specialized vehicles were also used in the improvement of service delivery to passengers and in maintenance of the airlines and the airport.

However, due to the fragile nature of the sector towards in the last decade of the century and faced with issues like the Gulf War and the constant need to restructure, the industry experienced a sort of downturn. While a drop in demand does not usually mean a shift toward other modes, it is usually reflective of the state of the economy during hard times as people opt not to travel to cut costs. So as to sustain survival of the industry airlines started to form alliances in the 1990s thus expanding their network and coverage and giving the traveler more options.

Maritime and inland waterway transport continued to be used to transport a huge proportion of cargo as compared to the mostly recreation passengers using this mode. Ferries still remained in use but with the development of road transport through building of bridges and more people owning cars their use slightly declined. Most of the bulky products like oil and manufactured goods are still transported by international waterways and entered the country through ports where other modes of inland transport and also inland waterways supplemented them.

Their importance is highlighted by the measures taken to curb the freezing of the St. Lawrence Seaway during winter in order to prevent losses arising from inability to access the channel. Most of the industries that are located near such seaways do so because of their transport needs and thus even with the development of other modes of transport; the seaways continue to be the main mode used while the others just supplement it.

The pipeline for supply of natural gas and oil also benefited from the supplementary modes development while it itself was upgraded further to increase capacity and efficiency. The road network eased access to such products and their demand through more automobile use while also opening up states like Alaska. They also relied on the water mode to establish these pipelines in locations of off-shore drilling.

The train system especially the subway had started to gain more prominence in usage in the 1970s.Initially in terms of infrastructure, little was done when compared with other modes, the vehicles used continued to be improved with newer and faster ones but towards the close of the century many cities started improving and also introducing their own networks (Shafto, 2009, para.1-13). Within the large cities the Metro systems played a major role in the decongestion of traffic especially easing the load during rush hours and coping with the population pressure as urban areas swelled.

Telecommunications is perhaps the most rapidly growing aspect in term of transportation and how it affects other modes. This period has come to be shaped by the Internet, its rapid development, spread and increasing influence on peoples lives. With the onset of the new age of telecommunication, mediums of communication like the letter and wired telephones were deemed traditional as the use of things like the cell phones and electronic mail replaced them with ruthless efficiency. Coupled with its high affinity for technological innovation to improve its delivery and efficiency, it soon developed a kind of must-have association for its products and usage.

Such developments reduced the influence of mainstream transport in the relay of information and reduced physical links that had been established for communication mediums like the telephone and fax. The contribution to the ease of congestion in traffic was huge and has continued to grow. Courier services saw the traffic of letters and other communications drop while the demand for transport of goods both locally and internationally grew due to increase in availability of Information.

As Rodrigue, Comtois and Slack (2006, p. 87) point out electronic communication has over the years gained importance with regard to transport. This is manifested with the shift towards things like online booking of flights that started toward the end of the century and also the advertising and informational relay to the targeted user. Vast areas that remained unknown were opened up by communication and they enjoyed more transport connections as businesses and tourists covered the areas.

Development as a sector of economy

With the growth of the sector, transport has seen its influence on the economy continue to grow. This influence is not limited to it being a factor of production but also as an industry in itself employing many people and setting up many factories. Costs of transport in many households are very significant and constitute a significant percentage of the spending.

Commercializations of the transport industry lead to investments into various fields and subsequently new entrants in terms of service providers. This brought about competition resulting in more variety for the user and better delivery of the service. Advertising and the increased availability of information also helped in raising the quality offered. It led to the sprouting of large global companies like car makers and airlines.

The influence on the economy as illustrated by Rodrigue, Comtois and Slack (2006, pp. 83-88) is great to the point where based on the efficiency and availability prices of commodities can be affected. Prices of things like crude oil can also be affected by transportation demand which explains why the price was generally appreciative toward the end of the century.

Telecommunication also gained influence on the economy o the country. Online transactions were introduced and businesses could be managed from afar. The innovations in telecommunications created a lot of jobs and changed how trading was done. Commodities like software were introduced through the Internet and a whole new industry created. However, some problems arose from such innovations such as piracy and the abuse of the industry which continue to threaten the gains made.

Conclusion

The period addressed was quite significant in the revolution of the transport sector with the new technologies and improvements incorporated in the sector. While others remained almost unchanged like the water transport, some underwent something akin to a facelift in particular telecommunication. These changes brought to the fore the need to constantly restructure the services offered in order to remain relevant and competitive in the industry.

Improvements in the modes of transport enhanced efficiency by allowing for the development of a sort of seamless inter-modal usage. For travel and transportation needs the outlook on the future remains bright with the growing influence of telecommunication and continued globalization. Travel it seems will in the future be reduced to only when necessary, and thus with the expected drop in population, mobility will be achieved and movement of goods, people and access to service will be improved.

Environmental issues also have to be addressed in making transport safer and cleaner to use. Coupled with the possibility of continued technological incorporation into cars planes and the likes, manufacturers have their work cut out in order to progress these creations with the changing times.

Individuals living in cities should also weigh up the acquisitions of items like cars as status symbols instead of looking at the value added by certain practices. In light of developing issues like terrorism that continue to rise governments should also tighten the security with regard to public transport systems and the likely impact of an attack.

References List

Federal Reserve Bank of San Francisco. (2000). What caused the debt to grow? Web.

Rodrigue, J. P., Comtois, C. & Slack, B. (2006). The Geography of Transport Systems. London: Routledge.

Shafto, D. (2009). Underground Railroads. Web.

Stanford Education. (2005). The Airline Industry. Web.

The National Atlas of the United States of America. (2009). Transportation of the United States. Web.

United States Department of State. (2009). The Economy in the 1980s. Web.

The yield curve is one of the most important concepts used by economists and fixed income analysts when it comes to analyzing bonds, getting a good grasp of conditions in the financial markets, and weeing out trading possibilities. It is basically the relationship expressed on a graph between the interest rates and the time to maturity of a given debt. Mathematically speaking, the yield curve is a function that is in terms of the time to maturity and it has to be for bonds with equivalent credit quality and expressed in a given currency.

The shape of the yield curve is considerably important for getting an idea about the trend of interest rate changes in the future and economic activity to come. The curve is usually asymptotically upward sloping with time. A popular explanation for this is that with time, investors find greater risk in putting their money in bonds and hence require an increased risk premium for investing. Hence, yield curve goes up with time. Another one is that the market is speculating risk rates rate to increase, because of which if investors delay investment, they may get greater returns. Therefore those investors who choose to invest at this time need to get compensation for the future rise in the risk-free rate, leading to a rise in the rate on long-term securities. The curve can otherwise be flat, steep, or inverted.

The shape of the yield curve could be described as relatively steep following 2002. It however began to flatten out over the years coming to 2004. It continued to flatten over the following time with the Fed short-term term rates but keeping long term interest rates low. Consequently, the yield curve remained inverted as well following the Feds policy. After that efforts were made to make the curve steep which did not prove very successful immediately but started to give results later on.

The market and the Fed have had different outlooks regarding policy that should have been adopted since 2002. The Fed funds rate remained negative in mid of year, below the CPI index. Market analysts argued that such a policy is consistent with recessionary conditions but not with healthy economic growth which leads to a rise in interest rates, requiring the Fed to take up its fund rate target which it shunned to do at that time. Its aim appeared to be to create a little inflation to aid the stock market and then control it after the desired effect was achieved. Analysts argued that this was not considering the potential ill effects of this move on the market which would have to be dealt with.

In the following years, however, the Feds outlook began to improve in the minds of the analysts. There was the conviction that interest rates are unlikely to be raised in the months in 2004 which prompted investors to buy long long-terms. This led to the flattening of the yield curve. However, the outlook began to deteriorate in the later years. The Fed boosted the federal funds rate to around 3.5 percent, as an attempt to keep inflation low. This was followed by speculation that the rate will continue hiking at an increasing rate which got analysts worried about whether the economy was strong enough to handle it and brought fears of prompting a financial crisis, not unlike that in the 1980s. Thus the general view from the news appeared to be that whether the curve got flat or inverted, it hinted towards a weaker federal reserve rather than a downturn of the economy.

With the inception of the new chairman Bernanke in 2006, it was hinted that the central bank may have to keep on raising interest rates to control inflation in the midst of expected and healthy economic expansion. He also had to address the growing concern that with interest rates on two-year treasury notes rising higher than ten-year notes, leading to inversion of the yield curve was not a signal of a downturn. Following the beginning of a slowdown in growth in 2007, the Fed kept up with the policy for controlling inflation which kept the yield curve flat, amid expectations of low volatility in economic conditions. Then the recession following the financial crisis began which prompted the Fed to help out the tanking banks. The gap between short-term and long term debt interest rates started to widen, leading to a steeper curve after a long time. This was a sign of economic recovery, contrary to the previous trends in the curve which was taken to be a good sign. This was because of aggressive rate-cutting by the Fed to help the banks borrow and encourage investors as well. However, it led to inflationary pressures which were considered necessary in order to avoid a deeper financial crisis.

Looking at the trend that the yield curve has taken following 2002, one gets the idea that the press explanation via market analysts faired better in terms of explaining the yield curve than the Feds reports. The biggest evidence of this was during the mid-years following 2003 when the curve got flattered and inverted in the long-term debt section which was continuously expressed as a sign of impending recession. The Fed chairman went to great lengths to show the contrary by pointing out the economic expansion during the years and the strength of the retail sector. However, the economy did eventually experience a recession, and only after the Fed initiated aggressive rate-cutting did the curve become steep with the longer-term debt having higher interest rates. This was a sign of recovery and more in tune with the economic conditions that prevailed.

Introduction

Overhead is analyzed into three broad groups, these are, production overhead, administrative overhead and selling and distribution overhead. It is important to grasp that although overhead is the same from whatever angle we view it from, the methods of overhead reduction will differ from one group to another. In the recent competitive times, companies face the problem of reducing costs and at the same time maintaining their products and services at a competitive level. Companies are forced to restructure their business models to cut company costs, this has been done through various methods such as, business process reengineering, business outsourcing, shared services and enterprise resource planning. By sharing services the company is able to reduce costs such as administration costs, rental costs and transport costs across departments, a company can reduce the overhead costs of hiring these services separately hence reducing administrative and selling and distribution overheads simultaneously. Business process reengineering is the process of transforming business processes to achieve improvement in performance, costs, quality of products and services and efficiency. It is important for companies to transform their business processes from time to time to ensure that they utilize their resources effectively and achieve maximum output. Through outsourcing, a company is able to minimize costs of production, for example when a company outsources a service like customer care; it is able to meet the clients need in an efficient and economic manner. Finally, through enterprise resource planning a company can avail information between departments cheaply and ensures management of the business in an efficient manner. Enterprise resource planning assists in the reduction of administration overheads if effectively implemented.

Fair value

Simply put, Fair value is an estimate of an assets unbiased market price. It refers to the market value of the assets and liabilities that a company has acquired over a period. Fair value makes futures contracts possible by representing a price level for buying and selling and is a function of cash value and any financial charges minus the dividends accrued to the future date of settlement. There is no single framework for measuring fair value and this has brought about inconsistencies in accounting for the fair value. This essay will explore the method of using quoted prices of similar assets and liabilities in estimating the fair value. For example, when assessing the fair value of a given stock in the stock exchange, it is important to study other stocks that are similar in nature to that particular stock. This study can be undertaken through observing the transaction involving these assets and liabilities and using the results to determine the fair value of that particular asset or liability. The use of quoted prices of similar assets and liabilities in estimating the fair value has a major setback in that it is difficult to find assets and/or liabilities that are identical. That includes assets and liabilities that have the same interest rates, yield, price etc. it becomes important to estimate fair value not by the prices of similar assets and liabilities alone but also based on the market trends and observations. If there is no external information on the asset or liability one may rely on internal information to measure the fair market value, internal information involves the assumptions made by the business entity itself regarding its value of assets and liabilities.

Advantages and Disadvantages of Shared Licensing Ventures

Shared licensing provides leeway for technological growth in business by allowing multinational companies to share intellectual property and rights. The exchange of ideas and information between companies ensures that information can move freely between organizations for mutual benefit. This is strategic for further expansion of the business. Sharing licenses also increases the companys capability by ensuring access to a wide variety of information that may be useful in the business in terms of improving output, efficiency and quality of goods and services among other things. By sharing licenses, companies can reduce the cost of acquiring that license individually, affordability of a license is important for business acquisition and improvement. Sharing licenses also reduces risk of failure. By observing, the trend among companies that share a similar licence, one company is able to predict future transactions and in the process reduce the risk of failure. Sharing licenses is harmful for business because it compromises exclusivity and further makes a company lose its competitive advantage. When only one company has rights to a particular product, it has advantage over other companies because it is the only company in the market able to produce those goods and/or services. If the companies share licenses then they would all be in competition in the production of those goods and/or services. Sharing licenses makes it difficult for a company to protect its trade secrets and this will not optimize the returns on intellectual assets. Sharing licenses ventures makes entry and exit into the industry easy, which is good for new businesses but bad for existing businesses. From this discussion, I draw the conclusion that sharing licensing ventures is a win-win approach and is therefore better than license exclusivity.

Microeconomics plays a crucial role when it comes to decision-making activities held by the individual units in the economic sector that affect the particular markets. Different principles microeconomist put forward; however, some tenets are highly discussed these days when pandemics changed the entire economic system. The purpose of this paper is to analyze the article called The Death of the Department Store: Very Few Are Likely to Survive and find out how it relates to the fundamental tenets of microeconomics.

The Death of the Department Store: Very Few Are Likely to Survive is the article published by two authors, Sapna Maheshwari and Vanessa Friedman, in The New York Times on April 21, 2020. Undoubtedly, the economic losses caused by the pandemic are immense across the world. According to Maheshwari and Friedman (2020), nothing felt worse than the weakened department stores industry. Seeing Macys, Lord & Taylors, Nordstrom, and The Neiman Marcus Group crushing down and some of them filing for bankruptcy is unimaginable as those stores were always thriving (Maheshwari & Friedman, 2020). Some university professors suggest that very few of them are likely to survive. At a time when the retailers are supposed to pack multiple orders, cash many checks, and prepare for the planned holiday season, they are forced to short staff, hoard cash, and skim the crisis plans. The authors claim that the upheaval caused by the pandemic will permanently alter both the retail landscape and the relationships of brands with the stores that sell them (Maheshwari & Friedman, 2020, para. 6). In general, the situation may even worsen, causing retailor-seller relations disruption and many financial losses.

The number of shops in each chain is expected to decrease. Macys representatives declared that they lost around half of their sales for only two weeks. Some retailers took extreme measures and let go of the chief executives, whereas Neiman stopped accepting new merchandise and furloughed a large portion of its approximately 14,000 employees (Maheshwari & Friedman, 2020, para. 15). The chain stores are trying hard to sustain the business and not to lose everything. As a result, they cut prices and offered shipping benefits. However, the rate of the order drops has increased despite the provided gains. According to the article, no one knows what the last quarter of the year will bring about, but the experts suggest resorting to Chapter 11 that would alleviate possible burdens. In general, the article aims to depict some critical microeconomics critical principles that are exposed to disruption due to the pandemic.

The first tenet that may be observed concerns the firms theory, which suggests that any organization aims to maximize its profits and avoid potential losses. The firm typically aims to fill in the gap between the costs and revenues by setting prices and demand on the market. Some organizations pursue to maximize profits either in a short-term or long-term period. Thus, the article may correlate to the theory of a firm for some specific reasons. First of all, the report suggests that all those department chains suffer from enormous losses. Therefore, they are trying hard to somehow restore the profits by creating special offers and sales, cutting personnel, or simply shutting down some of their stores. Moreover, those department stores goal was to maximize gain for an extended period. Now, however, they are endeavoring to navigate and adapt their economics in the short term so as not to go bankrupt.

The second principle the article may relate to is the supply-demand model. The law of supply and demand suggests the interaction between the sellers of some item or service and the buyer of this item or service. The law of demand states that at higher prices, the customers will purchase fewer goods. Meanwhile, the law of supply suggests that the sellers will produce and supply more products at higher prices. As the demand for clothes, accessories, shoes and other items has rapidly fallen, the market has weakened. Now, however, both supply and demand have fallen, causing financial losses. According to Maheshwari and Friedman (2020), across chains, prices for new merchandise sold via e-commerce have already been slashed by 40 percent in some cases (para. 15). The statement implies that due to the pandemic of COVID-19, the demand for the items and services offered by the malls has dropped. The source also states some brands said shipments have even been turned away (Maheshwari & Friedman, 2020, para. 15). It means that the suppliers do not send items to the sellers because it is too expensive

In conclusion, it is relevant to mention that microeconomics principles define different processes on the non-global market; however, they affect it in some way. The article relates to some tenets of microeconomics, such as supply-demand relation and the firms goals. Each organization aims to maximize profits and sustain the equilibrium of supply and demand. However, now, no company is insured from multimillion losses. Therefore, the department chains such as Macys, Nordstrom, and others are trying to fluctuate on the market while pursuing to create a crisis plan.

Reference

Maheshwari, S., & Friedman, V. (2020). The Death of the Department Store: Very Few Are Likely to Survive. The New York Times.

Purpose of Cost Allocation in US Corps of Engineers

Even though US Corps of Engineers is a branch of US federal government, there is the need for cost allocation for deriving an equitable distribution of the project costs among several projects authorized to be executed. In addition, there are legal regulations requiring reimbursement or cost-sharing which generally specify the cost recovery norms for specific service or function. This also necessitates a proper cost allocation among the different projects for purposes of reimbursement. Cost allocation provides information required for determination of the quantum and share of estimated projects costs that need to get reimbursed. This information is vitally important for testing the financial feasibility and plan acceptability of the authorized projects. The information arrived based on the allocated costs form the basis for subsequent planning and construction. Cost allocation also ensures that the cost accounts are maintained in accordance with the formulated plans and principles of allocation (USArmyCorpsofEngineers, n.d.).

Cost allocation Factors

Usually a cost allocation plan is developed by federal and state agencies like City of Seattle to share the operation costs accumulated in cost pools to all the benefiting partners. Cost allocation plan follows the steps of classifying costs and pooling them. Pooling costs implies the process of accumulating costs into pools pending allocation to benefiting programs and/or partners. The cost allocation plan may allocate individual cost items or the total of all cost items in the pool. The cost pools take the form of facility cost pools, categorical cost pools or organization cost pools. The allocation bases are determined based on the principles of minimal distortion, general acceptability, actual costs or effort expended and materiality of costs involved (Kentucky WIA Implementaion Team, 2000). In my opinion the selection of so many cost drivers is made to facilitate the identification of the cost of individual service or facility accurately. However I am not in favour of such a detailed analysis of cost drivers as after all such a detailed cost allocation base does not benefit the taxpayer in any respect. Therefore it is advisable to follow more uniform cost allocation based on the extent of utilization of the service or facility. In the government settings cost allocation is found meaningful to assess the financial feasibility and control of expenses within the budget. Even though in general cost allocation is associated with manufacturing companies, of late the efficiency of the federal and state agencies could be assessed by following an effective cost allocation method.

US Department of Human Services  Division for Cost Allocation

The Division of Cost Allocation (DCA) is located within the Department of Health and Human Services. Office of Management and Budget (OMB) has designated the Health and Human services as the cognizant federal agency to look after specific functions like allocation of cost and to review and negotiate facility and administrative cost rates which are the indirect costs (USDepartmentofHealth&HumanServices, 2005). The agency is formed to take up the exclusive functions of determining fringe benefit rates, special rates as determined to be appropriate and to conduct research on patient care rates. Since the functions like state wide cost allocation plans and public assistance cost allocation plans are specialized and exclusive functions the government has decided to entrust these functions to a specialized agency like DCA. In addition to these functions, DCA is expected to conduct resolving audits involving indirect costs and cost allocation methodologies. The agency also provides technical assistance and guides the Federal departments. DCA also provides technical assistance to other government agencies and the grantees.

Colleges, hospitals and other non-profit organizations can follow a simplified allocation method, multiple allocation method, direct allocation method or based on special indirect cost rates. The simplified allocation method and multiple allocation method depend on the benefits extended by the indirect costs to a single major function or several major functions in varying degrees. Direct allocation method is adopted where the non-profit organization treats all costs as direct costs. In some cases based on the factors substantially affecting the indirect costs, a special rate may be worked out for applying to the several major functions (OMB CircularA-122, 1980).

Relevance of Cost Allocation

It cannot be stated that the cost allocation is relevant only to the government agencies. Since indirect costs in any business or non-profit organizations, are costs related to a particular cost object which cannot be traced to it in an economically feasible way, there is the need for allocating costs arise in all forms of organizations. Since the indirect costs are a sizeable percentage of the overall costs assigned to the cost objects like products, customers and distribution channels the need to allocate costs enhances. In general cost allocation serves the purpose of providing information for economic decisions, motivating the managers and other employees of the organization, justifying costs or computing reimbursement and measuring income and assets for reporting to external parties. Since cost allocation has varied purposes it cannot be generalized that the cost allocation is applicable only in the context of government agencies. For instance if the salary of a aerospace scientist in the centralized research and development department of Boeing Corporation need to be allocated to different functions or departments to arrive at the performance of the divisions accurately. This salary may be allocated as a part of the central R&D costs, to satisfy the purpose of making an economic decision like pricing. However it may or may not be allocated for meeting the other purposes of motivation or cost reimbursement purposes. Nevertheless, cost allocation assumes an important role in arriving at the income and asset measurement in most of the cases of business and non-profit organization and for managerial decision making purposes.

References

1. KentuckyWIAImplementaionTeam. (2000). Cost Allocation Guidelines for Kentuckys One-Stop Service Delivery Centers.
2. OMBCircularA-122. (1980). Cost Principles for Non-Profit Organizations.
3. USArmyCorpsofEngineers. (n.d.). Cost Allcoation.
4. USDepartmentofHealth&HumanServices. (2005). Division of Cost Allocation.

Introduction

The strategic asset of the allocation ranges, as well as the tactical assent of the investment fund is the generally accepted universal aspect of analyzing the investment environment. Originally, this type of analysis is considered to be the most effective tool for defining the realities of the investment environment, nevertheless, it requires multi angled and complex analysis of the background factors. Thus the analysis of the investment environment is closely associated with the regional premises of the investment fund location, and the attention, which is paid to infrastructure. Originally, decision-making depends on selecting several regions, and the comprehensive considerations on the matters of the critical factors, thus, the paper will be based on the analysis of the special problems. The main aim of the paper is to analyze the current issues in the investment environment, present alternatives for plausible strategic asset allocations, and deliver recommendations for the fund committee. The paper will be also focused on the extents of the fund, which should be used in the relation of the active versus passive investment approaches in the different asset classes.

Environmental Analysis

Originally, the analysis of the environment is closely associated with the financial and investment risks, which any investment fund may be subjected to. Thus, there is a strong necessity to consider the necessity to analyze the risk and the structure of the investment flow from the perspective of these risks. Thus, in accordance with Holland and Riddiough (2002), it should be emphasized that the risk of failure is one of the most serious risks, which may be observed from the perspective of the risky environment. Consequently, it should be emphasized that the required level of the technical performance of the investment fund fully depends on the defects in the investment flow structure. In the light of this consideration, it should be emphasized that the necessity to ensure the required quality of financial management is closely associated with the achieving of the necessary capacity level of the planned investment flow. As it is stated by Murphy (2000, p. 431): This risk is usually a sequent of suppliers defaults and errors in projection. To reduce this type of risk in the conditions of the Russian economy it is recommended to make the examination of project execution in various stages.

Marketing risks are often considered less dangerous than project failure risks, nevertheless, this type of risks is closely associated with the matters of marketing strategy and unachieved plan volumes of sales. As Reid (2001, p. 128) emphasized in the research:

Marketing risk is usually the most essential risk in the processing stage of the investment project and is a consequence of price and demand fluctuations, market competition, errors in product choice, errors in the market appraisal, errors in market choice, the erroneous strategy of marketing and price-formation policy, failure of the advertising campaign.

Therefore, the necessity to arrange a proper design for the cash flow operations is the requirement of the highest value, and the requirements and aims of the investment environment information system should be the following:

• Retrieval of the investment environmental information. It means that the users of the investment fund should have an opportunity to retrieve the required spatial and non-spatial information on the required factors and aspects of the investment environment.
• The investment fund structure should be subjected to investment environment evaluation. Thus, the stakeholders of the fund should have an opportunity to select the factors, which influence the investment environment, get the full reports on the selected aspects, and make the corresponding amendments (Munter, 2004)
• Decision making analysis is the most important feature, which should be attributed to the investment flow structure. The stakeholders should be capable to leave their preferences for discussion and select the required decision from the perspective of the realities of the investment environment. (Jiang, 2006)

The realities of the investment fund are the following:

The fund holds £13.5 million of assets. 35% are stored in UK equities, 20% are in overseas equities, 15%  in UK corporate bonds, 20%  in UK government bonds, 5%  in commercial property, and 5%  in cash and short-term instruments. Consequently, the structure is rather detailed, and is aimed at responding to almost any type of environment, nevertheless, the corporate bonds are regarded to be the least stable for storing the financial resources. (Chung, Scholtes and Turner, 2007) Thus, in international capital markets, bonds need to be assigned a credit rating to make the issue marketable, while, in general, longer maturity governmental bonds have a longer duration. (Holland and Riddiough, 2002)

Considering the necessity to review the structure from the perspective of the investment environment, it should be emphasized that originally, the structures of the investment funds where stakeholders have an opportunity to withdraw their funds within a short term are generally flexible enough, for filling the occurred financial gaps. Thus, the funding structure should be the following:

Nevertheless, in spite of the decision-making board and the set of decision-making tools, the main force and power are after the stakeholders. (Murphy, 2000) The parallel chain of investors provides the required level of financial flexibility, thus, making the stakeholders free to invest and withdraw their funds. Nevertheless, as it is stated by Scott and Conwell (2006, p. 87):

A specific Stakeholder may not always agree with the experts of the decision-making board. The differences in decisions and preferences may relate to the issues of templates, candidates, evaluations of the project. Thus, the opportunity for users to establish their own decisions should be offered. Firstly, stakeholders may upgrade the existing decisions, which are common for their needs. Therefore, those modifications will enable stakeholders to make use of experts knowledge to satisfy their own needs at the same time.

UK Equity

Originally, UK equity may be regarded as the most stable financial asset, which may be resorted to for the tools of investment and funding. The fact, that UK stakeholders and investors prefer this form of equity is emphasized by the statement that up to two-thirds of the returns of this equity were originated from income. Thus, as Saigol (2006) emphasized:

UK equity income tends to be steady and unspectacular, but over the long term often wins the races. In the UK stock market, income is an important component of the overall return. Equity income funds also meet what I believe is the main objective for people approaching retirement, namely to grow capital and give income growth too. They could also appeal to younger investors, who can reinvest the income and benefit from many years of compounding that will enhance their return.

Overseas Equity

The strategic asset of the investment funding generally presupposes the necessity of storing part of the reserves in the overseas funds. The rules of the overseas equity storage presuppose the allocation of the financial reserves, and the funding of the investment projects coincided with the requirements of the bonding factor. Thus, numerous stock markets of Latin America are regarded to be beneficial equities for fund storage. (Scott and Conwell, 2006) In accordance with Morarjee (2008), it should be stated that it is the widely accepted practice, to store funds overseas, through the UK banking system:

It has indeed from the larger companys exposure and the emerging markets theme, with stocks such as Brazilian and Peru stock markets all performing well. As with all things, there is a downside too  in this case, the banking sector in the UK, which has continued to lag, and two other shares, which have recently been disappointing. However, the market has somewhat overreacted to the bad news on these latter two stocks, and they look good value.

In the light of this statement, it should be emphasized that the overseas equities may be regarded as the beneficial, but not stable enough tool for storing the reserves of the fund, consequently, the values of the overseas equities are covered only in the returns, which depend on the stability of the stock market. (Zarsky, 2003)

Corporate Bonds

As for the corporate bonds, the reliability of these aspects have been already defined, nevertheless, it should be emphasized that the terms of the total face value of the outstanding of the bond market values, the treasury of the UK and governmental agencies are regarded from the perspective of numerous options of bonding and choices. Thus, as Thomas (2008) emphasizes:

The bad situation of the economy recently regarding the credit crunch period, the corporate bond still highly recommended as good investment class compared with other classes. Europe corporate bond market had been reopened by National Grid Company (one of the UK companies) at the start of 2009.

Moreover, the corporate bonds are often regarded as the financial reserves, which are aimed at expanding the funding opportunities and performing the financial expansion operations. (Munter, 2004)

Government Bond

The governmental bond is the financially stable tool of funding and investment, nevertheless, it is closely linked with the governmental policy and the requirements of the governmental economic principles. On the other hand, these bonds are risky enough, as the government may change the taxes in order to redeem the bond at maturity. In accordance with Sharma (2006), these actions are associated with the risk-free tools, which are based on currency stabilization, subjecting it to devaluations and currency exchange rates changes for attracting or keeping the foreign investors. (Glasgow, 2008)

Commercial Property

As Thomas (2008) emphasizes, 25 percent of UK commercial properties fall in summer 2008. People believe that it is going to fall more. They presume that the market is going to fall more than 50 percent because of the struggling retail occupiers who are facing bankruptcy. Nevertheless, commercial property is one of the most reliable strategic assets, which are regarded by investment funds researchers. (Duyn, et.al. 2009)

Alternatives assets allocations

Allocation of the assets is the most important aspect of the investment funding, and, it should be emphasized that the correct allocation of the resources is generally defined by the necessity to save the funds, and get the income, simultaneously providing the opportunity of development for the invested project. Thus, considering the aspects of stability, benefits, and safety of the financial reserves, the best allocation variant is the following:

• 70 percent  government bond:
• 15 percent  corporate bond:
• 5 percent  UK equities:
• 5 percent  overseas equity:
• 5 percent  commercial properties:

Thus, as the government bonds are considered to be risk-free, the main part of the assets should be in governmental bonds. Considering the marketing situation, it is rather risky to have a higher percentage of assets in a corporate bond, nevertheless, by the forecasts, the situation will change, thus, there is no necessity to reject these bonds. (Tarzi, 2005)

As for the equities and commercial property, it should be emphasized that the original marketing situation is not favorable for supporting these equities financially, consequently, the low percentage is the best solution. (Baker, 2004)

Conclusion

Finally, it should be stated that the strategic asset of the allocation ranges is the generally accepted universal aspect of analyzing the investment environment. Consequently, the assets and the values of the economic principles, regarded in this paper, should be closely associated with the investment funding processes. Moreover, the allocation of the assets will not be full without the analysis of the marketing premises of the equities and bonds of various origins.

References

Baker, J. C. (2004). Foreign Direct Investment in Less Developed Countries: The Role of ICSID and MIGA. Westport, CT: Quorum Books.

Chung, J., Scholtes, S.,Turner, D. (2007). UK bonds retreat after rate shock, Financial Times Online, [internet] Web.

Duyn, A., Mackenzie, M., & Bullock, N.,(2009). Corporate bonds find hope from new issues, Financial Times Online, [internet] Web.

Glasgow, F., (2008). Fund managers find favor with corporate bonds again, Financial Times Online, [internet] Web.

Holland, A. S., Ott, S. H., & Riddiough, T. J. (2002). The Role of Uncertainty in Investment: An Examination of Competing Investment Models Using Commercial Real Estate Data. Real Estate Economics, 28(1), 33

Jiang, F. (2006). The Determinants of the Effectiveness of Foreign Direct Investment in China: an Empirical Study of Joint and Sole Ventures. International Journal of Management, 23(4), 891

Morarjee, R., (2008). Stagflation fears drive investors from equities,Financial Times Online, [internet] Web.

Murphy, A. (2000). Scientific Investment Analysis (2nd ed.). Westport, CT: Quorum Books.

Munter, P., (2004). UK gilt prices fall on interest rate worries, Financial Times Online, [internet] Web.

Reid, C. R. (2001). Environment and Learning: The Prior Issues. Rutherford, NJ: Fairleigh Dickinson University Press.

Saigol, L., (2006). Equity issues raise $15bn in Middle East,.Financial Times Online, [internet] Web.

Scott, M. S., & Conwell, V. (2006). Secrets of Successful Investment Clubs: Following These Strategies Can Help Yours Enjoy Longevity. Black Enterprise, 36, 87

Sharma, D. C. (2006). A Risky Environment for Investment. Environmental Health Perspectives, 114(8), 478

Tarzi, S. (2005). Foreign Direct Investment Flows into Developing Countries: Impact of Location and Government Policy. The Journal of Social, Political, and Economic Studies, 30(4), 497.

Thomas, D., (2008). Commercial property slump in the UK to last two years, Financial Times Online, [internet] Web.

Zarsky, L. (2003). International Investment Rules and the Environment: Stuck in the Mud?. Foreign Policy in Focus, 4, 1.

Introduction

Finance is the lifeblood of each and every business and capital budgeting is one of the important finance functions. Capital budgeting is the investment decision of a firm i.e. the decision of a firm to invest its funds in the long term assets efficiently. The investment decision may be for expansion, diversification, modernization etc. The firms value will be affected by the investment decision i.e. if a firms investment is profitable, the firms value will increase and it will show growth in the shareholders wealth. An investment decision is very much important in the present situation due to the following reasons: it influences the growth of the firm in the long run, the risk, and the fund position of the firm as it requires large funds. NPV (Net Present Value) and IRR (Internal Rate of Return) are the two widely used techniques and care should be given while choosing one of them for measuring the worth of an investment.

Part 1: Capital Budgeting Practice Problems:

a)

Below graph shows the discount rate at X axis and the net present value at Y axis. From the graph it is seen that the curve intersects the horizontal axis at 18% which is the internal rate of return.

Graph showing discount rate and net present value

b) Calculation of NPV

Graph showing discount rate and NPV

By plotting discount rate at X axis and net present value at Y axis we can see that the curve intersects the horizontal axis at 9% which is the internal rate of return.

c) Calculation of net present value.

Profitability index = Present value of cash inflows / Initial investment

Present value of cash inflows = 0.97 * $3.2 million= 3.104 million

NPV and IRR

NPV: it is one of the discounted cash flow techniques. It overtly recognizes the time value of money and says that the cash flow at different time periods will be different in their value. An investment project is selected through NPV by the following rule: If NPV>0 the investment project is selected. If NPV<0 the project is rejected and if NPV=0 the project may be accepted. Zero NPV shows that the cash flows generated are equal to the cost of capital. The NPV is calculated by the following equation: This is generally considered to be the best method for evaluating the capital investment proposal. Under this method cash inflows and cash outflows associated with each projects are worked out. The present value of cash inflows and outflows is then calculated at the rate of return acceptable to the management. Rate of return is considered as the cut rate and is generally determined on the basis of cost of capital. NPV is calculated as sum of the present value cash inflow minus sum of the present value of cash outflows. The steps involved in calculation of NPV are as follows.

1. Determination of an appropriate rate of interest to discount the forecasted cash flows.
2. Computation of the present value of cash flows by using the discount factor selected.
3. Calculation of NPV by subtracting initial capital outlay and commitments at various points of time from the present value of cash inflows.

Net present in the difference between total present value of future cash inflow and total present value of cash outflows. (Traditional value method: Explanation of net present value, 2009).

Advantages of NPV

1. This method recognizes the value of money.
2. It uses the desired rate of return fixed by management for discounting the cash flows.
3. NPV method is always consistent with the objective of maximizing the shareholders wealth, welfare and profitability.
4. The discounting process facilitates measuring cash flows in terms of present values.
5. This method is simpler than the IRR method.

Disadvantages of NPV

1. It does not indicate the rate of return which is expected to be earned from the project.
2. The determination of the desired rate of return is not simple in calculation and also to understand by different line managers.
3. It is very difficult to forecast economic life of project correctly.
4. NPV calculation requires the knowledge of discounting process.
5. It fails to give satisfactory answer when comparing project with unequal investment of funds and with different economic life periods. (The advantages and disadvantages of NPV, IRR and the payback rule, 2009).

The NPV is calculated by the following equation

NPV = [ C₁/(1+k) + C₂/(1+k)² + C₃/(1+k)³ + &..+ C_n/(1+k)ⁿ]  C₀ , where C₁, C₂, C₃, &. C_n are the cash flows; k is the discount rate and C₀ is the initial investment

Internal rate of return

IRR is also known as Yield method, Trial and Error Method, Marginal efficiency of capital etc. IRR is a modern technique of capital budgeting which takes into account the magnitude and timing of cash flows. IRR means that the rate of interest which equates the present value of future expected cash inflows, to the present value of cash outflows or cost of investment)

[ C₁/(1+r) + C₂/(1+r)² + C₃/(1+r)³ + &..+ C_n/(1+r)ⁿ] = C₀ , where r is the internal rate of return. An investment project is selected with respect to following rules: if IRR>k then the project is accepted, IRR.

Recommendation: Which method is better for making capital budgeting decisions: NPV or IRR?

In certain projects IRR will not be effective and the major drawback is that it uses only one discount rate to evaluate although it simplifies the calculation. From the above practical problems we can recommend NPV method for capital budgeting because IRR does not measure the actual investment or return. In case of negative cash inflows the value of IRR will be affected. In case of long term projects IRR is not suitable as the discount rates may vary in the long run. Using NPV has certain advantages because it uses multiple discount rates.

The same principle of NPV is applied to IRR. NPV shows future cash flows at different discount rates whereas IRR computes a break even rate of return at which the cash outflows equal to cash inflows.

Conclusion

The firms success depends upon the capital budgeting decisions taken by the management. There are many techniques used in capital budgeting for evaluating an investment project. Different companies use different techniques either NPV or IRR. Using IRR (Internal Rate of Return) and NPV (Net Present Value) often has the same findings. So while taking capital budgeting decisions cash flows should be considered and not the profits.

References

Internal rate of return. (2009). Investopedia: A Forbes Digital Company. 

The advantages and disadvantages of NPV, IRR and the payback rule. (2009).

Traditional value method: Explanation of net present value. (2009). 12 Manage: The Executive Fast Track.

As can be seen from the US/Euro foreign exchange rate, the lowering by Alan Greenspan of the US Federal Funds Rate, which was inflationary to the US dollar (devaluation) created an increase in value for the euro. From 2003 to mid 2008, the euro appreciated at a 12.2% compounded rate (FRED Economic Data n.d.).

With the onset of the financial crisis in 2008, there was a run to the dollar as it was the largest and most liquid currency, the reserve currency of the world. Also, the European banking system held significant dollar denominated assets, for which credit became non-existent virtually overnight, losing 21.9% into 2009 (FRED Economic Data n.d.).

In 2009 the Euro staged a significant rally, regaining lost value. This correlates to the initiation of the Federal Reserve under Ben Bernanke, of the first Quantitative Easing Program (QE1). The QE program was simply a massive inflation, to provide liquidity to the banking system directly, and the financial system indirectly. This took place in late March 2009 (FRED Economic Data n.d.).

The first QE program lasted approximately one year. With the inflation of the US dollar ended, the euro again lost value. Two more rallies and declines correlate closely with the two further QE programs initiated by the Federal Reserve: QE2 and Operation Twist (FRED Economic data n.d.).

These currency exchange valuations are quite rational as the exchange value represents the purchasing power of the currency for produced goods and services. An increase in dollars will allow increased purchases of European produced goods and services, which, will paid for in Euros, purchased by US dollars, pushing the price of the euro higher, and the value of the dollar lower.

With the onset last weekend of the change in the governments of Europe, the financial markets became nervous of the increased uncertainty in Europe. With Operation Twist scheduled to culminate at the end of June, the sell-off in the euro reflects both the political risk and the slowing of US inflation, although, with the current fiscal deficits and approaching US Presidential election, I would expect a further QE program to be announced sooner rather than later (FRED Economic Data n.d).

The financial crisis in Europe and America is at root cause, an excess of debt over the ability to service that debt. The origins lie initially with the Federal Reserve Bank and Alan Greenspan. With the tremendous stock market bubble in America that ran from 1982 to 2000, best exemplified by the dot.coms, which entered a bear market in April 2000, Alan Greenspan, then Chairman of the Federal Reserve, enacted monetary policy designed to prevent or shorten the recession that engulfed America. He lowered the Federal Funds rate to 1%. The result of this easy money policy was to encourage the expansion of house purchases (Hartcher 2006, pg.205).

Much has been made of the regulatory changes made by the US Congress and Senate in the lead-up to the crisis that has engulfed Western governments today.

While there is certainly some validity to these arguments, they miss the essential point. In the US and Europe, commercial banks are legally allowed to undertake fractional reserve lending. Fractional reserve lending is the use of a demand deposit, which is a contract that does not transfer ownership of the fungible deposit consisting of money, from the depositor, to the bank, to create new loans (De Soto 2006 pg.7).

The bank, must reserve a fraction of the deposit for liquidity purposes. This will vary based on reserve requirements set by the individual countries Central Bank. The remainder, can be loaned to a new customer. The new loan created, will be deposited into a bank account as a demand deposit.

The customer will at some point draw down on that loan, for the purpose that it was incurred. The new demand deposit that was created, can however be used as the basis for making a new loan to another customer. Once again, a reserve is made for liquidity purposes, and the remainder can create a new loan. The result is an expansion of the money supply through the expansion of credit in the commercial banking system. The expansion multiple is regulated via the reserve requirement mandated by the Central Bank.

The second change that spread this growth of debt worldwide was the sanctioning of mortgage debt to be pooled into securities, or, securitization. Thus a bank that made housing loans to customers, could, once a specific dollar figure of mortgage loans, sell those mortgages to investment banks who would package them into mortgage backed securities (MBS). These MBS were then sold to investors all over the world. This removed the mortgage loans from the commercial banks Balance Sheet, allowing the bank to start the whole process again.

So lucrative was this business to both the commercial banks and the investment banks in the layers of fees that they were able to charge at each stage of the process, that of course, the banks pursued this business, and declared increasing earnings from 2001 through 2007. As most of the banks are publicly traded common stocks, their share prices eventually responded to the increase in earnings.

The demand from the banks for new deposits, from which to leverage the creation of new mortgages, was driven by the high profitability that these fees provided. The money markets became a source of new capital, with which to create new mortgages from. The commercial banks knew that due to securitization, the new mortgages that they created, would in a short period of time, be removed from their Balance Sheets. In this case the banks undertook a risky strategy: they borrowed short and lent long.

This created a maturity mismatch. The money that they borrowed short, would fall due for repayment before the loan principal. The banks had two solutions to this problem: first, the mortgages on the banks Balance Sheet had to be sold to the Investment banks for MBS packaging, and second, they simply rolled over the short-term loans. The second solution was the best, provided one critical provision: that the money markets were able and willing to rollover the short-term loans.

In economics the law of supply and demand rules. The commercial banks had secured a supply of money, with which to continuously expand credit, and thus the money supply. They required a demand for this credit expansion. The flood of new credit that was flowing into the housing market had its usual effect, nominal prices started to rise due to the demand of new customers who had now qualified for a mortgage (FRED Economic Data n.d.).

The early applicants had reasonable credit scores, the banks undertook due diligence. The early mortgages that were packaged into MBS have had relatively lower default rates than later ones. This is because to satisfy a demand for their seemingly limitless supply of new money, the commercial banks lowered their credit scores required to qualify an applicant for a mortgage. In the end, there were no requirements at all. Anyone could, and did, qualify for a mortgage.

The quality of the mortgages granted declined precipitously. These mortgages became known as the sub-prime mortgages. These were also packaged as MBS and sold to investors all over the world.

There existed into 2006 a demand for housing, due to the massive creation of credit by the commercial banks, that could not be met by new supply quickly. It takes time for a new house to be built. Land has to be sourced, planning permission from local governments obtained for building permission of the type of building to be erected, labour and materials sourced, and finally if all the various requirements are fulfilled, building of new housing stock can be undertaken and completed (FRED Economic Data n.d.).

In 2006 the top of the housing bubble was reached in the US, as supply finally exceeded demand. The initial result was simply a pause, as prices stopped rising. As 2006 turned into 2008, and the interest rates under pressure from a rising Federal Funds rate, which under Chairman Bernanke, had been rising, the sub-prime area of the market started to default (FRED Economic Data n.d.).

The supply of MBS was for the Commercial banks and Investment banks, who between them created the supply of MBS, was so lucrative because of the demand for their supply. Pension Funds, Banks, Insurance companies, and Hedge Funds from all over the globe, purchased these securities. Why? Simply because many of them, Pension Funds and Insurance companies in particular, held long dated liabilities. MBS products provided them with a long dated maturity, that they could then match to the liability. Being that these were mortgages, they carried, relative to other fixed income, higher yields. Dont higher yields usually mean higher risk?

Higher yields are understood to carry higher risk. However the three ratings agencies: Standard and Poor, Moodys and Fitch, all rated the MBS securities with their highest AAA ratings.

The reason that they provided in the aftermath, was that the securities were diversified geographically, and that the US had up to that point, never suffered a national property recession. There had been numerous examples of regional property busts, California, Texas and Florida had at various time had property booms followed by busts, but never a national boom and bust concurrently. They reasoned therefore that due to that fact, and that due to the geographic diversification of the MBS products, that an AAA rating was fair.

The creators of the MBS products knew that there was a large demand for higher yielding fixed income investments. MBS products were therefore created with differing tranches of risk. The higher the yield provided by the MBS, the higher the concentration of lower credit quality mortgages constituted the tranches, pushing the yield higher. Now MBS securities had geographic diversification and credit diversification, which, the ratings agencies again awarded AAA ratings to.

When in late 2008 the defaults started in earnest, it escalated rapidly. The average write-off at US commercial banks averaged 0.20 or less since the 1980s with a couple of exceptions. From Q1 2004  Q3 2006 default write-offs were 0.10 or lower. In Q4 2006 they jumped to 0.15. They remained elevated, and started to rise. In Q1 2008 they rose to 0.85. By Q4 2008 they had risen to 1.63. In Q4 2009 they hit their current cycle peak of 2.85 (Board Of Governors of the Federal Reserve System n.d.).

When a loan is created through fractional reserve lending, creating an expansion of credit and the money supply, it creates a multiplier that is proportional to the reserve requirement. When a loan, created through credit expansion defaults, it creates a multiplier in a contraction of credit and the money supply. The default of a loan creates a deflation, or liquidity crisis, where there is not enough physical money to supply the demand to hold physical money.

Because MBS had been sold all over the world, to all manner of financial institutions, the contraction in the money supply shut off credit across all markets. The extent of the crisis can be seen directly in the LIBOR data. At the height of the banking crisis, banks essentially stopped lending to each other. Credit simply did not exist at this point, and this contagion spread all over the world. Probably for the first time since the 1930s bank runs were seen all over the world as depositors rushed to withdraw cash, as no-one was sure whether their bank could survive (FRED EConomic Data n.d.).

It was into this maelstrom that the Central bankers and governments acted, creating massive injections of new credit and money, which was supplied not just to the banking system, but eventually the entire financial system worldwide. The Federal Reserve before the crisis, held on its Balance Sheet less than $200 billion in reserves, expanded at the peak to $1.7 trillion in reserves. MBS held by the Federal Reserve on their Balance sheet was just below $1.2 trillion in 2009 (FRED Economic Data n.d.).

In addition to the Federal Reserve supplying as much liquidity to the banking system as required, the US government created the Troubled Asset Relief Program (TARP). This was signed into effect by President Bush in October 2008 and authorized $700 billion to purchase troubled assets, predominantly sub-prime MBS products from financial institutions. It was a further liquidity creating measure, required to counteract the deflationary forces unleashed through the rising default rate.

Europe was embroiled in this crisis in part because their financial institutions purchased US created MBS products, and second because they fueled their property bubbles through the same borrow short, lend long maturity mis-matches through the financial money markets, but the European banking system added a further layer of risk: they borrowed in US dollars.

When dollar credit froze, the European banks were at the point of collapse as they could no longer rollover the short-term maturities to refinance in dollars. The European Central Bank started a credit expansion, creating an expansion of euros, which were sold, purchasing dollars. In addition, the Federal Reserve initiated a Swaps and Repurchase program that supplied dollars to the European banking system (FRED Economic Data n.d.).

The result worldwide of the banking crisis, has been to create an employment crisis. With the significant expansion of employment within the building industry to satisfy the demand for residential and commercial property, when that demand evaporated almost overnight, employment in the building industry collapsed worldwide. When an industry expands to the degree that the building industry had, and then collapses, other areas of the economy suffer the loss of demand, and also have to reduce employment and their demand. The rise in unemployment worldwide and specific Euro areas has been a tragedy.

In Europe, the welfare state is more generous than that in the US. Automatic stabilizers take effect as unemployment levels rise, reconfiguring welfare entitlements and provision. This is not free. Government taxation provides the revenues required to pay for welfare programs. With fast rising unemployment, government revenues also fell rapidly. At the same time that government revenues were falling, their expenditures were rising, creating deficits.

In the Euro block the union was monetary, not fiscal. This meant that unlike countries that tied monetary policy to fiscal policy, allowing the massive printing of money (inflation), the European countries could not print money and devalue their currencies, but provide the money required to pay for their welfare programs. Their only option was to borrow. To increase the ratio of sovereign debt to Gross Domestic Product (GDP). This is exactly what they did.

The problem is that with the entire world in recession, and all that can, devaluing their currencies to promote exports, and by implication employment in those export industries, Europe could not individually devalue to promote exports. Exports became relative to Chinese, American and Japanese exports, expensive. This has maintained the unemployment levels, and increased them, putting even further strain on individual members with debt to GDP ratios.

The ECB, largely controlled by Germany, one of the few European nations that have weathered the storm, advocate severe expenditure cuts if that member requires additional loans. To date Ireland, Greece, Portugal, Italy and Spain are all in various stages of trying to implement austerity measures. The elections over the weekend, signaled the electorates dissatisfaction with the austerity measures imposed by the ECB. France elected an outright Socialist. Greece looks to need to stage further elections, and there is a real risk of Greece leaving the Euro area.

European banks hold significant values of sovereign debt. Why do they hold so much? This goes back to one of the great fallacies or myths: sovereign nations or governments do not default on their debt. You would think that this myth would have been long dead after Russia defaulted in 1998 on their Rouble debt, and the numerous Latin American defaults through the decades.

Even the US under Nixon, when he closed the gold window in August 1971 created a de facto debt default. Why then is it any surprise that Euro nations, struggling under enormous debt burdens, run the increased risk of default? If that is accepted as a reasonable assumption, why would banks purchase said debt?

To understand why the banking system is again at risk from sovereign debt the creation of credit must be examined. The ECB creates reserves for the commercial bank in question, and the bank sells Euro denominated bonds to the ECB. The commercial bank now has cash. A government can now incur Euro denominated debt through selling debt to the bank in exchange for cash denominated in euros. The bank, then repeats the process.

This can only continue for as long as the ECB purchases the Euro debt supplied by the government in question. The bank can also act on its behalf, purchasing debt from individual governments to gain the interest payments. If the debt purchased has a higher yield than the cost of funds, the bank will earn the spread less costs. This means however that the risker governments, to fund themselves, are required to pay a higher interest rate. The government cannot set through monetary policy its own desired interest rate.

The consequences of this are plain to see. Countries whose economic growth has slowed, earn less in tax revenues with which to service their current expenditures, thus to finance the deficit, they require further borrowing, increasing again the interest burden. Any commercial bank that purchases debt issued from a sovereign that has a deteriorating debt/GDP ratio, while gaining increased yield, runs the risk of a sovereign default.

If a sovereign does default, there is once again a contraction in the money and credit supply. Depending on the size of the default, once again a deflationary spiral could be triggered, that would necessitate a liquidity injection by the ECB, or potentially allow financial institutions holding excessive sovereign debt of that nation on their Balance Sheets, to fail. To avoid that problem, a restructuring deal has been put into place.

To date, the ECB under pressure from the Germans, have forced a Greek restructuring of their debt. This entailed an enforced acceptance of a reduction in principal. From Capital.gr.

The deal under dispute asked bondholders to give up 53.5% of the principal of their bonds by swapping them for new ones carrying lower interest rates and longer maturities but also a higher credit rating. Investors also received two-year triple-A European Financial Stability Facility bonds as an incentive to participate in the deal. In exchange, Greece was promised new loans totaling Euros 130 billion (Capital.gr 2012, para.6).

Also from the Wall St. Journal,

Greece said Wednesday it had completed the mammoth debt restructuring demanded by its international creditors in exchange for its new ¬130 billion ($172 billion) bailout, but it remains unclear what the country will do with the small group of dissenters who have refused to voluntarily sign up to the deal. Holders of this Greek debt have taken losses. The figure would have very carefully been calculated to spare any banking collapses when the principal was written down. In addition a mini-bailout also was part of the deal; with AAA European Financial Stability Facility Bonds providing I suspect, close to the lost principal write-down to the banks involved (Wall St. Journal 2012, para.1).

Currently, the Euro area under the European Central bank is undertaking the same solution that is being applied in China, Japan and the US: inflation. The ECB has under the Long Term Refinancing Operation, has expanded its Balance Sheet to almost Euros 3 trillion. From the Wall St. Journal;

LONDONThe European Central Bank handed out ¬529.5 billion ($712.81 billion) in cheap, three-year loans to 800 lenders, the central banks latest effort to arrest a financial crisis now entering its third year. Wednesdays loans were on top of the ¬489.2 billion of similar loans the ECB dispensed to 523 banks in late December. The ECBs goal is to help struggling banks pay off maturing debts and to coax them to lend to strained governments and customers. The takeup of this weeks loans was roughly consistent with what bankers, investors and analysts had expected. The December loans helped spur a large rally in Spanish and Italian debt, particularly among bonds that are maturing before the ECB loans must be repaid. This time, Spanish and Italian two-year bonds saw modest gains, pushing down yields. The price of Italian 10-year bond, a key indicator of investor confidence in the euro zone, also strengthened, pushing the yield to 5.19% compared with 5.31% before the ECB disclosed the size of its lending (Wall St. Journal, 2012,para.1).

In the long term there are only two possible potential solutions: the first is a common fiscal policy, the second, a break-up of the Euro-zone. Both have advantages and disadvantages, but one is far more likely than another.

The second outcome, the dissolution of the Euro-zone, has history on its side. Europe historically has developed under distinct cultures and languages. Countless wars, both major and minor have scarred the individual nations and populations. Existing political divisions divide any potential consensus being found, even if a thousand years of history could be put aside.

For a fiscal union to take place, which in practical terms means a common tax policy and welfare system, the country to whom the largest proportion of the tax bill would fall, would have to agree that their taxes went to support not Germany unemployed, but rather Greek, Spanish and Italian unemployed, with the French soon to be adding to the total, as the new Socialist government policies will rapidly expand that total. Simply, after footing the bill to absorb Eastern Germany back into West Germany, after the bankruptcy of Soviet Communism, the Germans will not.

This leaves the dissolution of Europe as a monetary union. This is probably for the best. The much touted advantages have been nothing but propaganda and a politicians pipe dream. From the Cato Institute;

The creation of the eurozone was presented as an unambiguous economic benefit to all the countries willing to give up their currencies that had been in existence for decades or centuries. Extensive, yet tendentious and, therefore, quasi-scientific studies were published before the launch of the single currency.

Those studies promised that the euro would help accelerate economic growth and reduce inflation and stressed, in particular, the expectation that the member states of the eurozone would be protected against all kinds of unfavorable economic disruptions or exogenous shocks. This is clear that nothing of that sort has happened. After the establishment of the eurozone, the economic growth of its member states slowed down compared to the previous decades, thus increasing the gap between the speed of economic growth in the eurozone countries and that in major economies such as the United States and China, smaller economies in Southeast Asia and parts of the developing world, as well as Central and Eastern European countries that are not members of the eurozone.

Since the 1960s, economic growth in the eurozone countries has been slowing down and the existence of the euro has not reversed that trend. According to European Central Bank data, average annual economic growth in the eurozone countries was 3.4 percent in the 1970s, 2.4 percent in the 1980s, 2.2 percent in the 1990s and only 1.1 percent from 2001 to 2009 (the decade of the euro) (see Figure 1).1 A similar slowdown has not occurred anywhere else in the world (Cato Institute 2012, para.2).

In the event of a Euro-zone dissolution, the euro will cease to exist, with a return to national currencies that prevailed before the euro. This is not a solution to the underlying problem which is not purely a question of currency, but rather a question of economic growth and productivity. Germany is the dominant economy, because it is the dominant producer, thus any currency that Germany utilizes, will reflect this economic reality.

Whether Greece, Ireland, or Portugal leave the Euro-zone, they will be able through a reversion to a home government controlled currency, in the short-term, be able to resort to the inflation strategy. This will not however create the panacea to their economic problems: it simply allows the day of reckoning to be put off to another day. The answer, however is unpalatable, the debt that cannot be serviced or repaid, must be defaulted on. This will allow the debt burden to be relieved.

Further the money monopoly enjoyed by government has been grossly mismanaged. It needs to be revoked, and a free market money such as the classic gold standard, where physical gold circulated as money, needs to be reinstigated, along with the abolishment of fractional reserve lending. With gold as a money, Europe, and the whole world would again be on a single currency. Banks on a 100% reserve requirement could not inflate the money system for fear of a bank run and insolvency.

To create growth, the natural rate of interest needs to drive the market rates of interest. Market rates of interest reflect consumers time preferences, present consumption against future consumption. To create economic growth, present consumption must be curtailed with increased savings that are invested in more roundabout productive processes that produce a greater quantity of goods. This increased supply lowers their price, assuming a constant demand.

Will Europe follow such a course? It is highly unlikely that the governments will voluntarily cede power. Unless their Keynesian policies bear fruit, this outcome may be forced upon them.

References

Cato Institute 2012, When Will the Eurozone Collapse? Web.

Capital.gr 2012, Greece completes exchange of EUR20.3 billion of foreign law bonds. Web.

Board Of Governors of the Federal Reserve System, n.d., Charge-Off and Delinquency Rates on Loans and Leases at Commercial Banks. Web.

De Soto, J. 2006, Money, Bank Credit, and Economic Cycles. Mises Institute, Auburn, Alabama.

FRED Economic Data n.d. Web.

Hartcher, P. 2006, Bubble Man. W.W. Norton Company Inc., New York.

Wall St. Journal 2012, Greek Debt Restructuring Leaves Dissent Question. Web.

Wall St. Journal 2012, ECB Gives Banks Big Dollop of Cash. Web.

Several injustices, such as racial discrimination and denial of voting rights, persist not only in the United States but also across the globe. Sadly, they weaken moral doctrines and constitutional principles that shape the prosperity of any society. The U.S. Constitution provides various rights and responsibilities to the citizens, helping to realize the American Dream. In this regard, there is uncertainty on the limits of the Americans active participation in political matters they perceive relevant or unethical. Some experts argue that it is essential to disobey the unjust laws that encourage social, economic, and political injustices (Walton et al., 2017). Although Americans should obey the constitution, they have a civic right to question the responsibility of their leaders. The citizens must express their dissatisfaction when a specific group or the entire population is oppressed. Therefore, American citizens have an indisputable duty to be politically active during times of injustices or gross violation of the constitution to safeguard the unity and peaceful coexistence of different population groups.

First, Americans confer the power to both federal and state governments through the election process, and they expect leaders to be responsible. Consequently, citizens act as overseers of government operations and can express their dissatisfaction if they feel their rights are overstepped. Corresponding to Martin Luther Jr.s assertion, Americans should use the three primary techniques, including negotiation, self-purification, and direct action, to fight injustices (King Jr., 1963). Negotiation is the most peaceful method and does not often involve the active participation of the people. However, when the government fails to address the populations concerns through negotiation and self-purification, then the latter have no option other than engaging in active political demonstrations. Besides, the U.S. constitution empowers citizens to participate actively in political matters, such as voting. Similarly, it allows people to hold their leaders accountable as their representatives, and, thus, there is nothing wrong with Americans participating actively in condemning injustices.

Americans also have a civil duty to facilitate the achievement of the American Dream. According to McKay (2017), citizens are the fundamental instruments in attaining any social, economic, or political goal. He adds that the American Dream revolves around all Americans, and every individual should create an environment that facilitates its realization through hard work, sacrifice, and risk-taking. In this regard, American residents have the right to condemn injustices, which impede their journey towards the dream. In organizing demonstrations against racial discrimination in Birmingham, Martin Luther Jr. acted as a role model for the Americans to realize that a time when actions work better than silence comes (King Jr., 1963). The U.S. Constitution guarantees the freedom of expression and assembly, and Americans should use this power to condemn injustices, which obstructs cohesiveness of their society. The American Dream can only be realized by citizens who can sacrifice their lives to fight for equity and rights of all people, irrespective of the cultural backgrounds, political affiliations, and economic status.

Additionally, Americans can enjoy the fruits of democracy by taking a bold step of disobeying unjust laws that undermine human dignity and morality. Agreeing to Martin Luther Jr.s letter to his fellow clergy, it is true that Freedom is never voluntarily given by the oppressor (King Jr., 1963, para. 11). People must use their power of assembly to show their discontent with existing disparities in the American society. According to Walton et al. (2017), political injustices arise from the violation of the citizens liberties or infringement of their rights. Indeed, the unfair procedures and inefficient political systems inspire the injustices, thus disregarding the democratic ideology that empowers individuals to express their views. While democracy gives superiority to the views of the majority, it does not warrant ignorance of the rights of the minority groups. Americans should advocate for a democracy that safeguards the welfare of every American resident.

Lastly, Americans must be politically active in condemning injustices because any contradicting actions support the persisting inequalities. It is irrational and morally wrong to witness the sufferings inflicted on fellow citizens and fail to condemn the perpetrators. As Martin Luther Jr. says, Injustice anywhere is a threat to justice everywhere (King Jr., 1963, para. 4). People may opt to remain silent and obey the unjust laws because they favor them. Unfortunately, remaining silent is similar to encouraging more injustices, and ultimately, everyone would experience the wrath of their silence. McKay (2017) also argues that speaking and condemning injustices through active demonstrations help leaders to envision the dissatisfaction of the people. Silence sends a message of satisfaction to the leaders, thus adding to the miseries of the oppressed. Americans should not fear to express their grievances using the best option, which would send a clear signal to rude and authoritative leaders.

Citizens have the responsibility and moral authority to shape the destiny of their country. While Americans have a civic duty to obey their constitution, they must safeguard the rights of the minority groups to realize the American Dream. Silence is not always a sign of obedience but sometimes signifies ignorance or a selfish behavior. It is illogical to remain silent when fellow citizens suffer owing to unjust procedures and laws. As Martin Luther Jr. explained to his fellow clergy, it is better to disobey unfair laws than permit injustices to be sanctioned to other communities. Therefore, Americans should be politically active in condemning injustices because it represents the best approach to exercise their power, promote democracy, and demonstrate sacrifice in strengthening human dignity and morality.

References

King Jr., M. (1963). Letter from a Birmingham Jail [King, Jr.]. Africa Studies Center  University of Pennsylvania. Web.

McKay, D. (2017). American politics and society (9^th ed.). John Wiley & Sons.

Walton, H., Smith, R. C., & Wallace, S. L. (2017). American politics and the African American quest for universal freedom (8^th ed.). Taylor & Francis.

To describe the stock and bond valuations that Tech Temps Company should invest in, it is essential to comprehensively analyze the factors affecting such valuations. This begins from their respective definitions of the individual terms and how the companies current financial status and objectives will influence buying specific stocks or bonds.

Stocks Valuation

Common and preferred stock are the two primary types of stocks sold by corporations and traded in the open market. However, their difference lies in the variation of their features. For instance, common stock is characterized to have a variable dividend, unlike the preferred stock that pays a fixed dividend. Moreover, common stockholders have a sense of ownership to a corporation; thus, they possess the capacity to elect its board of directors (Zutters & Smart, 2018). On the other hand, preferred stockholders do not have such voting rights. Third, any proceeds from the liquidation of a firm or dividend are usually paid to preferred stockholders before the former. Lastly, since preferred stocks have fixed dividends, they can be referred to as less risky and associated with a less amount of earnings.

Classified stock is defined as a type of common stock accompanied by special privileges, including voting liberties, dividends, and liquidation rights. In this instance, small companies that are going public might designate some stock as founder shares as they provide the privilege of voting right but have dividend restrictions.

It is essential to be aware that stocks are valued based on the present value of their future cash flows (Zutters & Smart, 2018). Since stocks are presumed to be held forever, their associated dividend streams or cash flows are infinite. Hence, the discounted dividend formula;

Where,

• P_o = Todays price of stock
• D = Amount of dividends
• r = Required return of stock

A constant growth stock is a type of stock whose dividends are expected to grow steadily forever (Zutters & Smart, 2018). It is valued based on the present values of their future cash flows. The Gordon Growth Model is used only if the stock is held forever; the dividends are growing at a constant rate that is less than the required rate; and dividends are expected to be paid at equal time intervals one year from now (Zutters & Smart, 2018). This can be represented by the following formula:

Where:

• Po = Todays price of stock

 = expected dividend one year from today

• g = Growth rate
• r = Required rate of return

If the growth constant is constant, and g is more significant than r_s, there will be a negative stock price. This further suggests that the firm has undergone supernormal growth and is popular among companies that are rapidly expanding, for instance, startups. Nevertheless, this cannot be sustained in the long-run.

If Tech Temps has issued preferred stocks paying stockholders a dividend equal to $10 annually, with a required rate of return of 8%, its market value can be calculated as follows:

• D = $10
• r_s = 8% = 0.08

Thus,

 = $12.50

Tech Temp Performance

Economic value added ((EVA) is used to measure the true economic profit of a firm (Zutters & Smart, 2018). Based on the financial statement, Tech Temps EVA is determined as:

EVA = EBIT (1  Tax Rate)  (Cost of capital% * Total capital)

= 500,000 (1  30%)  (10% * 1,250,000)

= $350,000  $125,000

= $225,000

From the above calculations, it can be seen that Tech Temps EVA for a period is positive. Therefore, this suggests that the profit generated by the company is greater than its cost of capital and this means an increase in the companys value over the period.

The Price Earnings Ratio (P/E Ratio) is the association between a companys stock price and earnings per share (EPS) (Cecchetti & Schoenholtz, 2016).

Market price per share = P/E * Earning Per Share:

• =20 * 2
• =$40

Bond Valuation

Other than stocks, individuals can also invest in bonds. A bond is characterized to have a face value of $1000 to $5000 (Ross et al., 2020). Secondly, most bonds pay interest after every 6 months, however, it is still possible for them to be paid monthly, quarterly, or annually. Moreover, they can be further categorized as fixed-rate (generates a constant interest rate) or adjustable floating rate. Fourthly, maturity of bonds ranges from a single day to as long as 30 years.

The value of a coupon bond can be determined by the flowing formula:

Where:

• P_b = Price of the bond
• r = Coupon interest
• F = Principal payment at maturity (par value)
• T = Interest payment in period
• C = Coupon value

Value of bond for 1yr =  = $1000

Value of 10-yr bond = Annual coupon payment * Discounted Cumulative PV@10% + maturity value for 10 years = (1000*0.1)6.14 +1000*0.386 = $1000

Interest rate price risk is defined as the risk of a reduction in the price of a bond as a result of increased interest rates. A 10-year bond has a higher interest rate price risk than the former. The longer the maturity period, the more extended the time that will take to pay off the bond, so that the investor can replace it with another one having higher coupons (Jordan et al., 2018).

Interest reinvestment rate risk is defined as the risk of reducing interest rates that might adversely affect the income from a bond portfolio. A one-year bond has a higher reinvestment interest rate risk than the latter. The shorter the maturity, the more limited the duration it takes to replace high old-coupon bonds with new low-coupon bonds.

References

Cecchetti, S., & Schoenholtz, K. (Eds.). (2016). Money, banking and financial markets. McGraw-Hill Higher Education.

Jordan, B., Miller, T., & Dovlin, S (Eds.). (2018). Fundamentals of investments: Valuation and management. McGraw-Hill Higher Education.

Ross, S., Westerfield, R., & Jordan, B (Eds.). (2020). Essentials of corporate finance. McGraw-Hill Higher Education.

Zutters, C., & Smart, S (Eds.). (2018). Principles of managerial finance, Global edition. Pearson.