Financial markets, banking, and risk
Businesses depend on banks and financial markets for funding, payments, and managing risk.
Banks and businesses
Banks provide businesses with deposit accounts, payments, loans, overdrafts, credit cards, and services such as foreign exchange. Banks assess loan applications by looking at character, capacity (ability to repay), capital, collateral, and conditions, often called the five Cs of credit.
Stock markets
Stock markets, such as the New York Stock Exchange and Nasdaq, let investors buy and sell shares of public companies. Share prices reflect investors' expectations of future profits. A rising share price makes it easier for a company to raise new equity and can boost managers' stock-based pay.
Bonds
Large companies and governments borrow by issuing bonds, promising to pay interest (coupons) and repay principal at maturity. Credit rating agencies, such as Moody's, S&P, and Fitch, rate the risk of default; lower-rated 'high-yield' bonds pay higher interest to compensate investors for risk.
Interest rates and businesses
Interest rates affect borrowing costs, investment decisions, and customer demand. When the Federal Reserve raised rates sharply in 2022-2023, many businesses faced higher costs for loans and lines of credit, and some delayed investment.
Business risks
Businesses face many risks: market risk (demand changes), credit risk (customers not paying), operational risk (breakdowns, errors, cyberattacks), liquidity risk (running out of cash), currency and interest rate risk, and reputational risk. Risk management identifies, assesses, and reduces these risks.
Insurance and hedging
Insurance transfers risks such as property damage, liability lawsuits, and business interruption to insurers in exchange for premiums. Hedging uses financial contracts, such as forward contracts to lock in exchange rates or commodity prices, to reduce exposure to price swings.
Fintech and payments
Financial technology has transformed business finance: online banking, digital payments, buy-now-pay-later services, crowdfunding platforms, and automated accounting software. Small businesses can now accept card and mobile payments cheaply and access online lenders, though these can carry high costs.
Worked example
A US company expects to pay a European supplier 1 million euros in six months. If the euro strengthens, the dollar cost rises. By signing a forward contract to buy euros at a fixed rate today, the company locks in its cost, giving up potential gains if the euro weakens in exchange for certainty.
Key takeaways
Banks provide accounts, payments, and loans, judged by the five Cs of credit. Stock markets trade shares whose prices reflect expectations. Bonds are rated by agencies; riskier bonds pay more. Interest rates affect costs and demand. Businesses face market, credit, operational, liquidity, currency, and reputational risks. Insurance transfers risk; hedging reduces price exposure. Fintech has changed payments and financing.
Flashcard
Character, capacity, capital, collateral, conditions
Check your understanding
Why might a company use a forward contract to buy foreign currency?