Quiz 9: Securities: Business Finance and the Economy: the Tail That Wags the Dog

Business

If a company plows back it's earning instead of giving dividends to its shareholder, then one would lose earning from investment. The following are the disadvantages of plowing back the earnings. Dividends are usually considered as an investment income. If the dividends are retained by a company, then it would lead to reduce the income on investment. Shareholders would lose the faith in company if it fails to provide dividends to the shareholders. People buy shares of a particular company aiming to receive dividends. The following are advantageous of plowing back the earnings instead of paying dividends to the shareholders. If the extra profit is used for further expansion rather than giving dividends to the shareholders, then the company can grow at faster rate. Growth of a company leads to increase the value of shares in the market. Shareholders are likely to gain more due to an increase in the value of shares. Thus, if the dividends are retained by a company, then it would lead to maximize profit of shareholders in the long run.

The value of bond is dependent on the rate of interest in the economy. If the annual interest and returns are given, then price of the bond can be measured by considering the annual payment and rate of interest. The following is a measurement of the price of bond. img Thus, considering the given annual payment and rate of interest, one would think that the price of bond will be $50.

A price fluctuation tends to increase when stocks are purchased despite higher price and they are sold when price is lower. Normally people would sell their stocks when the price is higher in the market. But, on the contrary, speculators behave irrationally; they sell their stocks when the price is relatively lower. This behavior of speculators tends to increase price fluctuations in the market. The following are two diagrams which indicate buying and selling of stocks. img The above diagram (a) indicates that a speculator demands for stocks is higher at higher price. The quantity supplied changes according changes in quantity demanded. The figure (b) shows that the stock is sold at lower price. The quantity demanded changes according to changes in the quantity supplied. If a speculator sells his stocks when the price is lower in the market, then he would have to bear the loss. Thus, buying when price is high and selling when price is lower is not in a best interest of a speculator.

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