Strategic Financial Analysis

Question: Write an essay about the ARM holding group. Answer: The ARM holding group is exposed to price risk on equity securities on its financial assets. The funds for such ventures are limited to the order , so that any potential decline of the value of the investment on its financial terms would not be substantial. Default risk is nothing but the uncertainties associated with the ability of the firm to meet its contractual obligations. Companies needs to manage their risks exposure and one of the methods of assessing the default risks is by using option pricing method. In this model, market information from option which motivated the transformation of profitability ratios, leverage ratios, and business risks are used to assess the default risks. The measures of financial performance have been used in a binary probit regression so as to examine the context of information and to estimate the default probabilities (Cont and Kokholm 2013). In the option pricing model, equity is considered as the as the call options on the companys assets. Shareholders or equity holders would have the right but not the obligation to purchase the assets of the firm by repaying debt to debt holders. The default probability of the firm and the market value of the equity is derived analytically by making assumptions regarding the risk free rate of interest and the value process of the firm. Let us consider a company with say, asset value A and a capital structure including equity S and a debt with zero coupon D maturing at time T. if now at time T, the market value of assets exceed the debt value that is , if A D, equity holders needs to exercise their options and make the repayment of debt. The debt holder would get D amount and the residual value would be obtained by the equity holders that is (A-D). on the other hand, if the market value of assets A, does not exceed the value of debts D, then it would be preferable for the equity holders to let the option expire by defaulting on the promised payment amount of D and exercising the right of limited liability,. So there would be two pay offs of either zero or ( A-D ) that is , the pay off would be. The dividend would be paid to the equity holders before the maturity of debt. The market value of equity would be derived using black schools model. The parameter that is the volatility of assets capturing the risks is not known . the volatility could be assessed using historical data. Now , we need to obtain the probability that the option of defaulting would not be exercised by the equity holder and it would expire. It is depicted as a function of the distance between the face value of debt which has been adjusted for expected growth in relation to the asset volatility and maturity period of debt and the market value of the assets of the firm. In this, the risky asset value does not take into account risk free rate . the expected return on the assets needs to be substituted for risk free rate of interest so as to convert the neutral risks to actual probability default. The difference between the actual probability default and the risk neutral gives the risk premium which is require d by the investors on the part of risks associated with default (Fan and Mancini 2012). The risk of loss when there is default and the timing of risk default, both are reflected in the risk premium. In the conventional approach, the financial performance characteristics such as efficiency, profitability, adequacy of cash flow, liquidity and leverage are pre identified. This theory uses a set of accounting based measures. For assessing the default risk, univariate discriminant analysis is performed on a number of financial ratios. The independent variable is weighed and score of multivariate probability is generated. The option pricing model has a limitation of predicting the default probabilities. Option pricing suffers from the disability of generating sufficient statistics . on the other hand, only statistical knowledge is required for the implementation of traditional model . the accounting information is extracted from the financial statement which appear either quarterly or annually and they suffer from deficiency of the reliability of accounting information as they are subject to accounting practice that are creative. The probability measures seems to be overstated and leads to be biased in managing the default risk. This issue was solved by the introduction of option pricing theory which uses a probit analysis in managing the default risks (Ji and Zhou 2015). So it can be concluded that default probabilities which are estimated from the option pricing method is considered to be having explanatory power in when it comes to assess the default risk as compared to the accounting based measures. Though it suffers form the disability of generating sufficient statistics so both the measures are combined to form a hybrid model of measuring the default risks. Coupling the accounting information with the market information would solve the issues. There seems to exist a significant and positive relationship between the financial performance and the corporate governance. A firm which is better governed are relatively more valuable, more profitable and is capable of paying more cash out to its shareholders. Some of the corporate governance factors which are associated with good performance are independence of nominating committee and government committee which meets annually, progressive practices , director educations and many more. The director and senior management of ARM holding follows the code of business conduct and ethics and they are required to act honestly and in a fair way. The business model of ARM is designed in such a way that the impact of its operating activity has a very low impact on communities and human rights. The governance framework of ARM holding is built around three pillars that is : Internal control framework Assurance of independence Organization processes and the corporate governance framework are in accordance with the financial compliance which is monitored through audit testing every year. This would help in maintaining good relationships with the shareholders and would form an optimism for the company that the investors would be willing to make investment in the company Good governance is expressed through a variety of factors accountability, reliability and predictability and it depends upon the member of the business of their ability to exercise their power and over time they are able to make good governance. In order to ensure the well being of the business several mechanisms are adopted by the senior management in order to safeguard the interest of the stakeholders. These mechanisms play an important role in improving the performance of the firm. A company with a better corporate governance is related with better marketing valuation and operating performance . there are many variables of standard and good corporate governance which effects the performance of the business such as size of board, CEO ownership , and board independence (Flammer 2015). Corporate governance include various programs and activities which enhances the financial performance of the company. Enabling a good social governance by being socially , economically responsible has attracted many investors , however the benefits derived from these does not provides the investors with superior returns. Good governance and financial performance has appeared to be a virtuous circle and it exhibits that the company having good governance exhibits good financial performance. Good managerial performance has also been said to be related with the good financial performance. It has been found that the companies having strong rights for shareholders tends to have lower capital for cost of equity. A company with good corporate governance would be able to reduce the agency problems between the management and stakeholders and this would result in increased or good financial performance. The business would be benefitted in the form of stocks performance which would be positive in the long run along with the certificate of quality management. A good managerial practice lead by the team of senior management experts would improve the bottom line of the company. In order to ensure a necessary balance of power between the stakeholders, effective corporate governance is needed. The financial reporting system would be able to disclose more reliable information if the corporate governance is effective .A good corporate governance would influence the motivations of managers towards the practice of financial reporting. The effectiveness of the boards and senior management would be promoted by previous by various attributes such as power, knowledge , information which in turn would influence corporate financial performance (Ameer and Othman 2012). The variables on which the financial performance is judged is liquidity, capital adequacy, asset quality and earnings. Corporate governance in general is influencing about 45 % of the financial performance of the companies. A good corporate governance involving the transparency in disclosures of the relevant items helps in strengthening the corporate governance principles which would help in building trusts with the stakeholders especially the investors or shareholders who park their fund by investing in the company. The integral parts of corporate governance include disclosure, trust and transparency which would have a great impact in improving the financial performance (Hassan and Ahmed 2012). A corporate governance survey carried out by price Waterhouse cooper, many investors are prepared to pay premium for companies which has practices of good corporate governance. Framework of corporate governance and financial performance : In the above chart, we can see that how the financial performance is related to the factors and which include macro economic variables and the financial transparency , trusts and disclosure which forms a part of good corporate governance. A good corporate governance also ensures that there is an effective channel of information for disclosing the information to the stakeholders. The expectation of stakeholders by using a strategic direction can be attained through corporate governance. Poor financial performance is alleged with the doubtful corporate governance (Daily et al. 2015). If a good corporate governance which ensures transparency to its various stakeholders such as regulators , public, and equity holders would survive with a high capital adequacy ratio and better return on net worth. So a good earning would come form a good corporate governance. 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