Firm Investment Analysis
Asset allocation is one of the most critical factors of allocation since it impacts both equity and fixed income. Asset allocation is done by many investors in their portfolios to ensure that they have made the right decisions so that they can earn high returns on their capital and so that their portfolio gives them an excellent asset allocation strategy over time. Many investors are of the view that a good asset allocation strategy is one that involves the use of many types of assets, especially derivatives, as these can capture more risk and return and thus offer a better option for those investors who are looking at long term value for money. However, there is another school of thought that says that good asset allocation strategies should involve the use of fewer derivatives and that their value is not directly related to the amount of risk that is involved in the portfolio. This latter approach to asset allocation has recently gained much ground as this approach has been found to be much more effective than the earlier approaches.
One of the ways in which this concept can work is through the concept of government intervention. The idea here is that the government may introduce a policy that ensures that the firm investments that are made in times of financial crisis is offset against future losses. In other words, the firms are prevented from making too much loss and are instead enabled to divert the surplus funds that are generated during the crisis period into more secure and viable areas. This would go a long way in ensuring that the firm investment portfolio is made far more effective through the use of derivatives. For example, if the government decides that the distribution of funds during the crisis period should be shifted from safe stocks into safe bonds, then this can be achieved through the use of derivatives.
This does not mean that the distribution of funds should simply be distributed according to the profitability of the firms. Instead, it should be allocated according to the risk that is attached to the firm. This may include the kind of risk associated with the firms’ location or its economic structure. For example, if the distribution of funds during the economic turmoil is done according to the firm’s geographical location, this would serve the purpose of allowing the distribution of funds to be done only during times of extreme economic stability. However, if the location of the firm is threatened by natural disasters such as earthquakes, the distribution of funds could be limited during times when the firm’s operations tend to slow down. In this manner, the use of derivatives can ensure that the firm enjoys optimal protection against external disturbances such as disasters.
Through the government intervention that is brought about by the introduction of these derivatives, the firm investment efficiency is improved. For example, during the recent financial turmoil, some countries experienced a decline in their gross domestic product growth rates. In addition to that, the stock market turbulence in some countries also resulted in large losses for the firms’ investments. As a result of these developments, the stock market liquidity dried up leading to large losses for the firms’ investments. On the other hand, the use of derivative products resulted in government interventions that were able to avert these disasters from occurring.
In order to understand the relationship between the government intervention and firm investment efficiency, it is important to first understand the role of the financial crisis as a root cause of these disasters. When economies experience a decline in their Gross Domestic Product growth rates, the unemployment rate is likely to rise. Given that there are increasing numbers of unemployed people, businesses and financial institutions become unstable and are not able to cope with the sudden influx of workers. Because they are not capable of coping with the increased demand for their products, they are forced to make large-scale purchases of raw materials and other goods and end up exacerbating the inflationary spiral.
The introduction of the fiscal policy and the economic stimulus package as well as the injection of fiscal and monetary stimulus programs resulted in the dampening of the capital market volatility. As a result of these measures, firms are able to increase their capital inflow but at the same time, reduce their need for external financing. Thus, the inflow of external funding increases while the need for internal funds decreases. Moreover, the inflow of external capital ensures that firms have access to long-term credit facilities without any constraint, which in turn, results in optimal utilization of the firms’ investment and human capital. By facilitating optimal utilization of the firms’ investment and human capital, fiscal policy and the interventions by the government play a critical role in firm decision making.