Understanding Financial Intermediaries and Market Ratios
Financial Intermediary
A financial intermediary acts as the middleman between two parties in a financial transaction. While a commercial bank is a typical financial intermediary, this category also includes other financial institutions such as investment banks, insurance companies, broker-dealers, mutual funds, and pension funds. Financial intermediaries offer several benefits to the average consumer, including safety, liquidity, and economies of scale.
Financial Markets
- Primary Market: Markets in which corporations raise capital by issuing new securities.
- Secondary Markets: Markets in which securities and other financial assets are traded among investors after they have been issued by corporations.
- Public Markets: Markets in which standardized contracts are traded on organized exchanges.
- Private Markets: Markets in which transactions are worked out directly between two parties.
- Spot Markets: Markets in which assets are bought or sold for immediate delivery.
- Futures Markets: The markets in which participants agree today to buy or sell an asset at some future date.
- Physical Location Exchange: Formal organizations having tangible physical locations that conduct auction markets in designated (“listed”) securities.
- OTC Market: A large collection of brokers and dealers, connected electronically by telephones and computers, that provides for trading in unlisted securities.
- Stock Market: The most active secondary market and most important one to financial managers, where the prices of firms’ stocks are established. (Financial managers’ goal: maximize their firms’ stock prices.)
- Dealer Market: Includes all facilities that are needed to conduct security transactions not conducted on the physical location exchanges.
Financial Ratios
Liquidity Ratios
Ratios that show the relationship of a firm’s cash and other current assets (CA) and current liabilities (CL).
- Current Ratio: CA/CL. This indicates the extent to which current liabilities are covered by those assets expected to be converted to cash in the near future.
- Quick (Acid Test) Ratio: (CA – Inventories)/CL
Asset Management Ratios
A set of ratios that measure how effectively a firm is managing its assets.
- Inventory Turnover Ratio: Sales/Inventories
- Fixed Assets Turnover Ratio: Sales/Net Fixed Assets
- Total Assets Turnover (TAT) Ratio: Sales/Total Assets (TA)
Debt Management Ratios
A set of ratios that measure how effectively a firm manages its debt.
- Debt Ratio: Total Debt/TA
- Times Interest Earned (TIE) Ratio: EBIT/Interest Charges – A measure of the firm’s ability to meet its annual interest payments.
Profitability Ratios
A group of ratios that show the combined effects of liquidity, asset management, and debt and operating results.
- Operating Margin: EBIT/Sales
- Profit Margin: Net Income (NI)/Sales
- Return on Assets (ROA): NI/TA
- Basic Earning Power (BEP) Ratio: NI/Common Equity
Market Value Ratios
Ratios that relate the firm’s stock price to its earnings and book value per share.
- Price/Earnings (P/E) Ratio: Price per Share/Earnings per Share
- Book Value per Share: Common Equity/Shares Outstanding
- Market-to-Book (M/B) Ratio: Market Price per Share/Book Value per Share
Du Pont Equation
A formula that shows that the rate of return on equity can be found as the product of profit margin, total asset turnover (TAT), and the equity multiplier. It shows the relationships among asset management and profitability ratios.