ACTG 210 Financial Accounting

1. Explain in a high level of depth if the policymakers and regulators reinforce default- free pricing of debts collateralized by tangible assets. This endows transparency in their trading. It also leads to efficiency as it results in a complete market setting, which is not only resilient to shocks, but also reduces funding constraints on businesses. This efficiency vitalizes economic growth.

2. Explain how Securitization thus enhances the welfare of market participants, making the financial system more efficient?

3. Explain how Secured debt is an important source of financing for innovation? 

4. What are the advantages and disadvantages using intellectual property as collateral of each arrangement, and how to best position their IP to make it attractive for potential lenders. 

 

Policymakers and regulators reinforcing default- free pricing of debts collateralized by tangible assets

In case of collatering any asset for taking any loan or advances from the university or the college, the loan taker or the company has to deposit some asset to the loan provider that is the financial institution or the bank. In collateral asset, the policy maker and regulators has allowed the company to deposit tangible as well as intangible assets (Government printing office, 2011, 578).

Default is considered as one of the most crucial factors in financial market, this is the reason that has lead attention to the default risk pricing from the investor and financial institutions point of view. At each and every level the financial institutions and investor faces risk on nonpayment of debt on time. To answer this effectively, the investor and institution has to analyze the risk and return factor of the investment. The pricing describes about the probability of default of debt. Toanalyze the default rate of the debt, time factor has to be analyzed that is time describes the ability of the company or debtor to pay off the debt amount on time. According to the time factor it can also be analyzed the capability of collateral security to generate sufficient cash for the repayment of debt (Great Britain, 77).

If the debt is collateralized by the assets of the company or investor, it is called as tranches. These tranches receivespayment in cash flows in return of the debt and including the default factor of nonpayment. This is called as collateral pool. In case of collateralized debt obligation, the lender or financial institution has three options to gauge the liquidity factor of the assets held as security, those are: which asset can lead to maximum generation of cash to the lender in case there is any default in the payment, protection given to the lender in case of credit default swaps, cash flows in case of default able securities (Gray, 2017, n.d.).

To establish credibility in the debt instruments the policy makers and regulators has to form an effective policy by considering the asset collatered by the company to the lender or the loan provider. The policy makers and regulators not only have to consider the lender and loan taker into the consideration but also the impact on growth of the nation. For this the policy makers and regulators has to do a lot of interventions such as: they need to inject liquidity in the market which is never done before earlier by providing suitable credit facilities for the lender as well as for the companies, they need to make the policy easier to understand for the parties of lending, injecting money into the financial market by various policies and issuing various instruments, besides this it also provides some schemes related to the asset held as collateral in respect of the loan (Hogenes, 2014).

After the financial crisis in 2008 the capital market has adopted a lot of changes in respect of price, quantity and credit distribution. This was applied to all entities whether multination corporation or small and medium enterprise. As by applying to the traditional approach of lending, the company has faced various financial constraints in the financial market. Hence the policy makers and regulators has to follow up this change in terms of economic downturns by introducing a wide range of nonbank debt instruments to make the lenders and as well as the company’s strong enough to bear shocks of the financial and capital markets.

After the financial crises of 2008, the policy makers and regulators have given specific attention to the collateral securities, as it is the only source from where the loan payment can be realized if the loan taker has unable to repay the amount of debt. Policy makers and regulators have formed policies at regional as well as on global level in terms of cause of the bankruptcy by forming the positive statements due to which the investor and financial institution were misleaded. Besides this it was found by the policy makers and regulators that collatered agreements lead to shadow banking, hence suitable procedures must be taken to avoid the financial risk in future period (BlommesteinHans, Vincenzo, Allison and Yibin, 2010, 1-27).

At the beginning of 2013, the European commission has formed some policies so to ensure transparency majorly from the perspective of the clients. This has leaded the regulators and policy makers in forming policies in such a way that has led to reduction in the margin level in collateralized financial market. To increase transparency and reduce the constraints involved in collateralized transactions, the regulators and policy makers has formed policies in which the only those assets were preferred to be collateral which are capable of highly traded in the market and are priced in effective manner. This has led the financial institutions, companies and economy as a whole in capable of bearing shocks. This endows transparency in their trading. It also leads to efficiency as it results in a complete market setting, which is not only resilient to shocks, but also reduces funding constraints on businesses. This efficiency vitalizes economic growth. However these issues and policies formed by the policy makers and regulators haveled to decline in the value of collaterals in the market.Besides this it has created fear in the minds of companies and loan takers who possesses highly leveraged capital and have short term liquidity with them. These have led the financial transaction freeze but in longer run, it has led growth in the financial sector and has changed liquidity crises into solvency crises (Haentjens, Pierre de Gioia, 223).

Besides all these rules and regulations as formed by policy makers and regulators, they have also imposed conditions on reuse of collatered assets, the banks and financial institution has to provide a detailed disclosure of each collateral transaction to safeguard the interest of financial institution as well as of the loan taker. The formation of rules and regulations in respect of collateralized loans would lead to reduction in shocks for banks, financial institution and for loan takers such as companies.

In case of impact in the economic growth due to collateral transactions, it has lead to dramatic increase in the economic growth. The reason behind this is collateral is the base of free flow of credit markets, it reduces the risk of non payments by the lender for the financial institutions. Collateral assets which can lead to safeguard the interest of financial institution are as account receivable, inventory, plant and machinery, land and building. Collateral transactions includes intangible assets also which are as: patents, copyrights, intellectual property etc. In case of small and medium companies, collateral plays a considerable role in increasing the growth factor. In case of small companies, the assets can be leveraged or held as collateral for investing the amount into somewhere else profitable unit. This leads to increase in the economic growth of the company as well as of the country as a whole. Besides this, collateral transactions lead to increase the availability of credit and reduce the level of cost of credit.

After analysis of the assignment it is concluded that the policy makers and regulators have to form such policies which can lead to reduction in shocks for the lending institutions such as banks and the companies and organization which has taken loan. This would not only lead to reductions in shocks but also lead to increase the transparency and increase in the growth of the economy. For making such reforms, the policy maker and regulators has introduced the concept of collateralizing the intangible assets as they are more capable of generating revenue for the company as compare to tangible assets (Dongsheng, 2015, 77).

In case of funding constraints, traditionally the organizations and companies were only supported on the basis of labor and money. These resources were limited, due to which the organization has lack of capabilities which leads to constraint in the growth of the investment and opportunities. If a company or any organization lacks in funding requirement, it can lead to liquidity constraint for the company, hence by collatering the assets of the company and organization, can lead to increase the growth opportunities and increase in the investment opportunities.

Raising of funds by collatering the intellectual property has raised a lot in the modern financial market. In traditional era, the funds were raised by collatering some asset or cash flow to the finance provider. In this case the only those assets could be considered as collateral if they were tangible, such as land and building, inventory, account receivable. This was done for the purpose of security, as if the company fails to repay the amount, the financial institution can exercise the payment by using the assets put for collateral purpose in the financial institution (William and George, 2010, 177).

Securitization enhancing the welfare of market participants

In this, it has been described that how securitization can lead to increase in the welfare of market participants, and led to more efficiency in market. Securitization helps the investors in sharing risk effectively. For sharing risk in an effective manner, discipline in market is required. Market discipline is considered as considerable factor inanalyzing the sharing of risk (Lota and Gert, 88-191). Securitization is a process in which liquid assets or consolidated group of assets are taken for the purpose of financial engineering, and changing them into security. The market participants are: stock brokers, investors, stock brokers, depository, settlement banks, transfer agents, clearing house and listed companies. Securitization is a financial practice which defines the liquidity of various debts such as residential mortgages, auto loans, and commercial mortgages by transferring them to any third party investor as securities (Harold, 2015).

Securitization can lead to increase in the welfare of market participants by: it helps in reducing the financing cost by securitizing the cash flows and leading massive growth in borrowing costs. It helps in reducing the mismatch between assets and liabilities, by reducing the exposure of price and duration of security basis. It also aids the companies in reducing the level of required capital in their financial structure. In case of some companies, they are not allowed to hold capital more than the limit as decided by the statutory authority such as in case of banks it is the reserve bank. Hence by doing securitization of the assets, the market participants are able to remove such assets which are qualified for accounting purpose from the financial statements while maintaining the earning power of the assets. Besides this, securitization helps in transferring the risk such as: liquidity risk, credit risk and prepayment risk from the entity that cannot bear that risk. By locking the profits from the block of assets can lead the market participants in investing into more profitable investments. Market discipline is called as third pillar of Basel II. Market discipline can be understood as the ability of the market participants to analyze and interpret effectively the information of market (Bhavesh, 2012, 708).

Secured debt as an important source for finance innovation

Financial innovation is doing advancement or applying any innovative strategies in the financial instruments and their payments. Innovation in finance is required so to make effective lending and borrowing system. Finance innovation can be in terms of changes in technology, credit generation, transferring risk, equity generation, these factors helps the organization in increasing the credit for borrowers and making new ways to raise the capital from equity source (Samuel, 2012, 198).

Innovation in finance can be applied by two methods which are as: internal source of finance innovation and external source of finance innovation. Internal source of finance innovation are those sources of funds which are retained in the capital structure of the organization that is these funds are not distributed between the shareholders. These funds are bifurcated in provisions and reserves such as: retained earnings (Luisa, David, Reinhard, 2009, 41). While in case of external financing, this does not use the internal funds of the company rather to finance the capital structure of the company, it prefers to raise the money from outside the company such as, raising the capital from equity, and debentures etc. to effectively create innovation in external financing, the financial manager must have knowledge regarding the operations of risk and rewards of various securities operating in the market. Hence it is clear by the above analysis that internal source of finance is in the hands of the company whereas external source of finance are outside the control of the company, therefore they require major attention. There are various sources of external finance which are as: debt financing, stock market financing, business angels, venture capital, and many more (Christopher, 2011, n.d).

In case of debt financing, the company finds out the various opportunities for raising funds from public and private sources to develop their business. Banks, financial institution and government securities are considered as one of the preferred source of raising finance. In this financing, the funds are raised from third party. For rising of debts from third party the company requires to pay the money in return in the form of repayment of principal and interest amount. Debt can be raised in the form of loans from banks and financial institutions (Cornelia, 2012, 77). The advantages of raising funds through debt are as: the company or the business can retain equity capital; debt financing consists of fixed interest, it also has flexible repayment options. Besides such advantages debt financing also poses some disadvantages which are as: it requires regular payment of principal and interest amount, hence if the business is at its initial stage, the cash flow does not ensure about the regular payment of money in the business, if the company is unable to pay the money of debt, the business personally can be held liable for the repayment of debt, if the company possess high debt equity ratio, that is debt are very much higher than the proportion of equity in the capital structure of the company, the investor would be least interested in case of investing into the company (Meyrick, n.d.).

Debt financing is considered as one of the crucial source in case of finance innovation. The reason behind this is it allows the company in raising the finances by meeting the requirements of capital structure, and leading to innovation. However in case of companies which are engaged in innovation business, as in this business the cash flows are uncertain, hence it is very difficult for the company to make the payment of debt. Debt financing is highly preferred in case of innovating business; the reason behind this is, it helps the business in meeting the requirement of capital and making the management efficient in focusing on the innovation aspect of forming the business strategy (Cindy, Nichol, 22).

In case of secured debt, the funds are raised by collatering the financial assets of the business to the financial institution or banks or the institution providing finance. This is a preferred choice of the business which are engaged in the innovating business, the reason behind this is, these business does not have assurance of regular cash flows hence, if the company fails to repay the amount of debt, the financial institution can realize the amount of debt from the assets collatered of the company. Hence this provides an assurance to the company as well as the financial institution that funds can be realized even if the company will not be able to earn sufficient cash flows (Suhas, Dilip, 2008, 21).

Advantages and disadvantages using intellectual property as collateral of each arrangement

Intellectual property can be used as collateral for various financing agreements. Intellectual property is considered as financing innovation for raising funds from the financial institution. However for raising funds on the basis of collatering intellectual property is served by some special banks and lenders. These special lenders provide an extensive range of services for the borrowers who wants to raise the funds. Funds through intellectual property can be raised by Intellectual property collateral enhancement, intellectual property backed loans, and intellectual property sale, intellectual property royalty securitization, and license back transactions (Prasanna, 2013, 32).

In case of innovation finance intellectual property can also be treated as collateral for raising the funds.Intellectual property is also called as mix of asset based financing and cash based financing. That is in such financing besides collatering the tangible assets; the company also put some intangible assets as collateral security with the fund provider. Here intangible assets are as: trademarks, patents, etc. are also considered as collateral security. These are the reasons that haveled to increase in acceptance of intangibles as collateral security (Myron , Fred, Milton, 2016).

The advantage of using intellectual property as collateral is it is considered as a part of asset and cash based financing, where besides tangible assets, company can also use its intangible assets as collateral. Hence by this, the scope of raising the funds for the company which has limited sources has increased. In case of increase in the service sector in the world economy it has led to increase in the demand of collatering intangibles in the industry. Incomparison to asset based lending and cash flow based lending, asset based lending can be said as preferable, but it requires an extensive collateralization to raise the funds as well as its appraisal to protect the lender from nonpayment. In case of cash based lending the liquidity is more as in comparison to asset based financing (Riles, 2011, 22). Besides this, in case of intellectual property lending, the company are allowed to raise large amount of funds on the basis of multiple source of earnings. Intellectual property provides various opportunities that lead to increase in the credit availability for the borrower that is company. The company can avail the benefit of lower cost of funding if it can avail the benefit of credit from the fund provider for the intangible assets collatered. This opportunity cannot be availed by the company in case of asset based financing. Besides this, it also leads to increase in the return of owner or investor, as the money is secured in lump sum that gives an opportunity for the investor in invest somewhere else to avail the benefit of higher return. It is preferred that finance should be done on the basis of intellectual property, if it gives a clear view of strength and performance of that asset, as this is the only one which would lead to generation of regular cash flow. Besides this, if the intellectual property collatered with the financial institution is generating more cash flows as compare to the organization as a whole, this is said as preferred option to be availed by the company to raise finance, as this would lead to reduction in the execution cost (De, 2009, 35).

Finance innovation also poses some disadvantages which are: if the earnings would decline of these cash based assets, it would also lead to reduction in finances. In case of Startup Company dealing in only one intellectual property can lead to risk generation for the company. The reason behind this is, if that intellectual property fails to generate sufficient cash flows to repay the debt, it can lead to loss for the company and may be termination of the company. The valuation of intangible such as intellectual property is very difficult for the lender as well as the financial institution as compare to value the tangible assets which can be held as collateral for raising the funds. This is the reason that collatering intellectual property is not adopted by all the financial institutions. For disposing off the collateral securities, tangible assets are more liquidated, as they can be sold easier as compare to intangible assets (International monetary fund, n.d., 37.

Positioning IP to make it attractive for potential lenders

For making the intellectual property attractive for the creditors or finance providers, the intellectual property must address about: terms and payment of the funds raised, price of the portfolio, going concern of the entity, market in which that property is used, the potential users of intellectual property (Seven-Eric Barsch, n.d. 578).

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