Text 3 Banker to the u.S. Government

In addition to acting as banker to banks, the reserve banks fulfill a second major function: banker to the federal government. Like business firms, or even households, the U.S. government requires certain banking services. Receipts come in and payments continually go out, mostly in checks, and the two are rarely synchronized perfectly. At times, receipts exceed payments, and the surplus must be invested. More often, payments must be made before receipts come in, or payments exceed expected receipts, and the shortages must be financed for short or long periods. The Federal Reserve assists either directly or indirectly with these and similar needs of the U.S. government and with some needs of federal agencies.

As banker to the federal government, the 12 Federal Reserve banks and their branches handle the Treasury's "checking account," that is, they handle the Treasury's tax receipts and expenditures. The most straightforward way to handle this account would be for the U.S. Treasury to deposit in the Federal Reserve banks all tax checks from the public and to have the Treasury pay all the expenditures of the U.S. government with Federal Reserve checks, that is, checks drawn against the U.S. Treasury's account with the Federal Reserve banks.

Actually, only the second part of this proposition is what really happens: All payments by the U.S. government are made with Federal Reserve checks (paper or electronic). The funds for these checks, however, are in commercial banks and other depository institutions, where they stay until needed to support the checks drawn against the Federal Reserve account. At that time the funds are transferred from these depository institutions to the reserve bank against which the check is drawn. In other words, all government funds are deposited with private institutions, which benefit from this arrangement, and not with the federal government's federal bank.

Some might conclude that this beneficial arrangement for banks is the result of lobbying by the powerful banking industry. Actually, there is no sinister motive; this symbiotic relationship between the public and private sectors actually improves the conduct of monetary policy because it gives the Fed better control over nonborrowed reserves. As a matter of fact, until recently, tax receipts were deposited with reserve banks, and the Treasury's expenditures were made by drawing checks on those accounts at the reserve banks. This procedure, however, caused problems for the Fed. Treasury deposits with the Fed are one of the "other liabilities" in the Fed's balance sheet and, hence, are a technical factor affecting reserves. Like currency, these deposits are a competing use of reserves, or a factor absorbing reserve funds. As a result, increases in Treasury deposits drain reserves from the banking system, reserves that could otherwise be used to support deposits.

Text 4 Discounting, Rediscounting and Discount Window Loans

The interest rate Federal Reserve banks charge on loans to banks in their district is called the discount rate. The facility, or division, through which these loans are provided is called the discount window, and the loans are called discount window loans. The least mysterious of these terms is the window, referring to the actual win­dow where at one time Fed tellers made loans to banks. But why the term discount? What is discounted? Today, nothing is discounted; discount loans are merely loans of reserve funds to banks in need of reserves.

The Federal Reserve Act of 1913, which created the Federal Reserve System, provided for the Fed to make loans to banks. Actually, the act provided for “redis­counting commercial paper.” All of these terms have their origins in the early history of central bank practices, especially in Europe and Japan, on which the Fed’s practices were patterned.

To understand discounting and rediscounting, let us imagine ourselves back at the early years of the Fed’s life. (This also permits us to use the present rather than the past tense.) Imagine a retailer in Raincity, Washing­ton, who places an order with a manufacturer in New York for 100 umbrellas to be delivered in three months, in time for the coming rainy season. He signs and gives to the manufacturer an IOU, or “bill of exchange,” of $1,000, which promises payment of that amount at the time of delivery. The New York manufacturer, however, wants to be paid at once. He takes the bill to his bank, NY Bank, which “discounts” the paper. That is, NY Bank pays the manufacturer the present value of the three-month $1,000 bill, which, of course, is less than $1,000; hence, the term discounting. The two parties agree that in calculating the present value NY Bank uses the cur­rent three-month interest rate. The bank now has in its portfolio the bill signed by the Raincity retailer. In effect, NY Bank has made a three-month loan to the retailer at the market interest rate.

Next, suppose that on the same day NY Bank real­izes that it needs more liquidity and decides to sell this IOU by endorsing it to another bank, Streetbank. The buying bank discounts it, that is, pays the present value of the $1,000 face value. Of course, if Streetbank uses the same interest rate in the calculation, the selling price would be exactly what NY Bank paid the manufacturer. NY Bank can also sell the paper at the discount window of its banker, the New York Fed. In this case, the New York Fed “rediscounts” the paper. If the discount win­dow officer uses today’s three-month market interest rate to calculate the paper’s present value, NY Bank will be paid the same price that it would have received from Streetbank. The Fed would merely provide NY Bank liquidity. This service would be especially valuable to banks in areas with limited access to financial markets.

If the discount window officer calculates the present value using a discount rate lower than the market inter­est rate, the price that NY Bank receives will be higher. In this case, the Fed’s service to the bank is more than merely providing liquidity. It is a source of profit for the bank. The difference between the price the bank paid to acquire the IOU and the price it receives at the discount window is a result of the difference between the interest rate on the paper and the discount rate the Fed used. In effect, NY Bank borrows from the Fed at a lower rate (the discount rate) than the rate it charges the retailer.

Central banks, including the Fed, learned early on that by changing the discount rate, they could affect the profitability of borrowing from the Fed and thus affect the amount of credit in the economy. Until the 1930s, discount rate policy was the principal, if not the only, instrument of monetary policy.

In modern times, the Fed does not make loans to banks by rediscounting paper in their possession. The Fed simply makes outright loans, called advances. Per­haps to underscore the history of discounting or to keep up appearances, the Fed normally requires borrowing banks to post supporting collateral paper, even though “borrowers in good financial condition who seek short-term adjustment credit may be permitted to hold their own collateral appropriately earmarked.”

Text 5

A Brief History of the Federal Reserve

The authority to create and regulate money rests with Congress, which is empowered, according to Article 1, Section 8, Clause 5, of the U.S. Constitution, "to coin money [and to] regulate the value thereof." By enacting the Federal Reserve Act in 1913, Congress, in turn, created the Federal Reserve System and authorized it to create money and regu­late its value. In designing the Federal Reserve System, Congress benefited from the experience of other countries central banks.

By the time the Federal Reserve was founded in 1913, the phrase "regulate the value" had acquired an interpretation broader than mere regulation of the purchasing power of money. The Federal Reserve Act came in the aftermath of several financial panics, which were accompanied by the failure of many banks and nonfinancial businesses and by the disruption of commerce and general economic activity. In response, the act was specifi­cally designed to provide the country with enough liquidity, to provide facilities for discounting commercial credit, and to improve the supervision of the banking system. Thus, from the beginning, the Federal Reserve Act mandated the functions of the Fed: (1) to provide enough money and credit to facilitate economic activity and (2) to super­vise banks. In other words, safeguarding the health of the economy and the health of the financial system itself were the dual ultimate goals of the Federal Reserve.

By working toward these goals, the Fed hoped to prevent bankruptcies of financial and nonfinancial businesses and disruptions in economic activity. It failed, however, to avert the Great Depression of the 1930s, when thousands of banks and even more nonfinancial businesses failed. The level of economic activity became so weak that it could support only a shockingly small proportion of the labor force. Unemployment soared.

In the aftermath of the Great Depression, the Banking Acts of 1933 and 1935 amended the form and functions of the Federal Reserve. In addition to giving the Fed power to regulate rates on savings and time deposits, the 1933 act established the Federal Open Market Committee (FOMC), the third component of the Federal Reserve System. The 1935 act restructured both the Board and the FOMC by removing the secretary of the Treasury and the comptroller of the currency from these two bodies, thereby making the Fed more independent. The next major amendment came with the Depository Institu­tions Deregulation and Monetary Control Act of 1980 (DID&MCA). As Chapter 5 points out, this act deregulated deposit rates and subjected all depository institutions to reserve requirements.

These three acts—the Banking Act of 1933, the Banking Act of 1935, and DID&MCA of 1980 — were concerned with the Fed's role as a regulator both of the banking industry and of economic activity. Two additional acts focused primarily on the Fed's role as a regulator of economic activity. The Full Employment Act of 1946 directed the govern­ment to promote "maximum employment, production, and purchasing power." The term government was interpreted to include the Federal Reserve. The goals of monetary policy were further refined by the 1978 Full Employment and Balanced Growth Act, commonly called the Humphrey-Hawkins Act in honor of its prime sponsors, the late senator Hubert Humphrey and Congressman Augustus Hawkins. The preceding years had been char­acterized by high and rising inflation rates. The Humphrey-Hawkins Act instructs the Fed to pay attention to the rate of unemployment ad the rate pf growth of real GDP but also to the rate of inflation. It also requires the Fed to report semiannually to Congress about its outlook on economic activity and inflation and to relate this outlook for the economy to that set down by the administration in the annual Economic Report of the President. Additionally, the Humphrey-Hawkins Act requires the Fed to set and report on targets for money growth. The requirements of the Humphrey - Hawkins Act reflected not only the public's awareness and concern about inflation but also the ascendancy of mone­tarism, a school of thought whose basic tenet is that inflation is caused by excessive growth of monetary aggregates.

To date, none of the laws mandates a rigid set of practices to which the Fed must adhere regardless of economic conditions. The practices that the Fed has pursued in striving to achieve its twin goals of safeguarding the health of the economy and the health of the financial system have changed over time, as the Fed has adapted to the economic and political realities of the day.

Unit 5 . Accounting

Text 1

Deloitte, Touche, Tohmatsu

The name of this world-known auditing company  Deloitte, Touche, Tohmatsu  owes its existence to its founders who, from the very start of their careers, realized the importance of world-wide practice. The history of the company can be traced through their names; Deloitte, Touche, Tohmatsu.

Deloitte. William Welch Deloitte was one of the fathers of accountancy. He came from a rich French family who had to leave France during the Revolution. He began learning business at the age of 15 working as an assistant to the Official Assignee at the Bankruptcy Court in the City of London. At that time accountancy profession grew from its early days in the business of sorting out the affairs of bankrupts. At the age of 25 Deloitte opened his own office opposite the Bankruptcy Court in London. He was the first independent auditor in Britain. He made his name with the industry of the day – the railways. In 1849 he discovered frauds on the Great North Railway and invented a system of accounts to protect investors from mismanagement of their funds. His reputation as a professional accountant was rather high. Some years later he became president of the newly created Institute of Chartered Accountants in Britain. In 1893 he opened offices in the United States and began to audit different businesses.

Touche. George Touche came from Scotland, and when he qualified as an accountant in Edinburgh, there was no e at the end of his name. It was Touch and was pronounced in the same way as the Scottish loch. But since it was often mispronounced he decided to change it later. In 1883 he graduated from Edinburgh University and set off to the south to seek his fortune. Investment trust business was experiencing a boom, and that gave him a chance for making a career in this field. He took up saving businesses, from financial disasters which were very gre3quent in those days because investment trust business was quite new. George Touch had a lot of clients and had to work very hard. Soon he earned a very good reputation for a true flair for his business and honesty. In 1899 he started his own business 'George A.Touch and Co'. In 1900, he and John Niven set up the firm of Touch, Niven and Co in New York. Many large companies of both in the US and Britain became his clients. His company enjoyed high reputation and popularity among businessmen.

Tohmatsu. The Japanese company of Tohmatsu owes its origin to Admiral Nobuzo Tohmatsu. He started his career as a naval attaché at the London Embassy. At that time he was also an instructor at the Naval Academy. Many of his students were talented people taking interest in economics. Tohmatsu took an interest for accounting. He qualified as a certified public accountant at the age of 57. After that he became president of the Japanese Institute of CPAs. At that time Japanese government wanted to establish national audit firms. Tohmatsu, together with one his student decided to respond to the challenge. So in 1968, Tohmatsu and Co was incorporated. From the very beginning this company was internationally focused. It was not surprising, that it merged with another globally focused company Deloitte Touch.

Today Deloitte Touch Tohmatsu is one if the largest auditing companies of the world. It provides their clients with efficient consultative services wherever they are.

Text 2

AICPA Code of Professional Conduct

51 Preamble

1. Membership in the American Institute of Certified Public Accountants is voluntary. By accepting membership, a certified public accountant assumes an obligation of self-discipline above and beyond the requirements of laws and regulations.

2. These Principles of the Code of Professional Conduct of the American Institute of Certified Public Accountants express the profession's recognition of its responsibilities to the public, to clients, and to colleagues. They guide members in the performance of their professional responsibilities and express the basic tenets of ethical and professional conduct. The Principles call for an unswerving commitment to honorable behavior, even at the sacrifice of personal advantage.

Section 54 - Article III: Integrity

To maintain and broaden public confidence, members should perform all professional responsibilities with the highest sense of integrity.

1. Integrity is an element of character fundamental to professional recognition. It is the quality from which the public trust derives and the benchmark against which a member must ultimately test all decisions.

2. Integrity requires a member to be, among other things, honest and candid within the constraints of client confidentiality. Service and the public trust should not be subordinated to personal gain and advantage. Integrity can accommodate the inadvertent error and the honest difference of opinion; it cannot accommodate deceit or subordination of principle.

3. Integrity is measured in terms of what is right and just. In the absence of specific rules, standards, or guidance, or in the face of conflicting opinions, a member should test decisions and deeds by asking: "Am I doing what a person of integrity would do? Have I retained my integrity?" Integrity requires a member to observe both the form and the spirit of technical and ethical standards; circumvention of those standards constitutes subordination of judgment.

4. Integrity also requires a member to observe the principles of objectivity and independence and of due care.

Section 56 - Article V: Due Care

A member should observe the profession's technical and ethical standards, strive continually to improve competence and the quality of services, and discharge professional responsibility to the best of the member's ability.

1. The quest for excellence is the essence of due care. Due care requires a member to discharge professional responsibilities with competence and diligence. It imposes the obligation to perform professional services to the best of a member's ability with concern for the best interest of those for whom the services are performed and consistent with the profession's responsibility to the public.

2. Competence is derived from a synthesis of education and experience. It begins with a mastery of the common body of knowledge required for designation as a certified public accountant. The maintenance of competence requires a commitment to learning and professional improvement that must continue throughout a member's professional life. It is a member's individual responsibility. In all engagements and in all responsibilities, each member should undertake to achieve a level of competence that will assure that the quality of the member's services meets the high level of professionalism required by these Principles.

4. Members should be diligent in discharging responsibilities to clients, employers, and the public. Diligence imposes the responsibility to render services promptly and carefully, to be thorough, and to observe applicable technical and ethical standards.

Section 55 - Article IV: Objectivity and Independence

A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.

1. Objectivity is a state of mind, a quality that lends value to a member's services. It is a distinguishing feature of the profession. The principle of objectivity imposes the obligation to be impartial, intellectually honest, and free of conflicts of interest. Independence precludes relationships that may appear to impair a member's objectivity in rendering attestation services.

2. Members often serve multiple interests in many different capacities and must demonstrate their objectivity in varying circumstances. Members in public practice render attest, tax, and management advisory services. Other members prepare financial statements in the employment of others, perform internal auditing services, and serve in financial and management capacities in industry, education, and government. They also educate and train those who aspire to admission into the profession. Regardless of service or capacity, members should protect the integrity of their work, maintain objectivity, and avoid any subordination of their judgment.

3. For a member in public practice, the maintenance of objectivity and independence requires a continuing assessment of client relationships and public responsibility. Such a member who provides auditing and other attestation services should be independent in fact and appearance. In providing all other services, a member should maintain objectivity and avoid conflicts of interest.

4. Although members not in public practice cannot maintain the appearance of independence, they nevertheless have the responsibility to maintain objectivity in rendering professional services. Members employed by others to prepare financial statements or to perform auditing, tax, or consulting services are charged with the same responsibility for objectivity as members in public practice and must be scrupulous in their application of generally accepted accounting principles and candid in all their dealings with members in public practice.

Unit 6. Finance

Text 1

Bull and Bear Markets

Simply put, bull markets are movements in the stock market in which prices are rising and the consensus is that prices will continue moving upward. During this time, economic production is strong, jobs are plentiful and inflation is low. Bear markets are the opposite-- stock prices are falling, and the view is that they will continue falling. The economy will slow down, coupled with a rise in unemployment and inflation. In either scenario, people invest as though the trend will continue. Investors who think and act as though the market will continue to rise are bullish, while those who think it will keep falling are bearish.

What causes bull and bear markets? They are partly a result of the supply and demand for securities. Investor psychology, government involvement in the economy and changes in economic activity also drive the market up or down. These forces combine to make investors bid higher or lower prices for stocks. To qualify as a bull or bear market, a market must have been moving in its current direction (by about 20% of its value) for a sustained period. Small, short-term movements lasting days do not qualify; they may only indicate corrections or short-lived movements. Bull and bear markets signify long movements of significant proportion. The best-known bear market in the U.S. was, of course, the Great Depression. The Dow Jones Industrial Average lost roughly 90 percent of its value during the first three years of this period.

Investors turn to theories and complex calculations to try to figure out in advance when the market will scream upward or tumble downward. In reality, however, no perfect indicator has been found. In their attempts to predict the market, economists use technical analysis. Technical analysis is the use of market data to analyze individual stocks and the market as a whole. It is based on the ideas that supply and demand determine stock prices and that prices, in turn, also reflect the moods of investors. One tool commonly used in technical analysis is the advance-decline line, which measures the difference between the number of stocks advancing in price and the number declining in price. Each day a net advance is determined by subtracting total declines from total advances. This total, when taken over time, comprises the advance-decline line, which analysts use to forecast market trends. Generally, the A/D line moves up or down with the Dow. However, economists have noted that when the line declines while the Dow is moving upward, it indicates that the market is probably going to change direction and decline as well.

A key to successful investing during a bull market is to take advantage of the rising prices. For most, this means buying securities early, watching them rise in value and then selling them when they reach a high. However, as simple as it sounds, this practice involves timing the market. Since no one knows exactly when the market will begin its climb or reach its peak, virtually no one can time the market perfectly. Investors often attempt to buy securities as they demonstrate a strong and steady rise and sell them as the market begins a strong move downward. Portfolios with larger percentages of stocks can work well when the market is moving upward. Investors who believe in watching the market will buy and sell accordingly to change their portfolios. Speculators and risk-takers can fare relatively well in bull markets. They believe they can make profits from rising prices, so they buy stocks, options, futures and currencies they believe will gain value. Growth is what most bull investors seek.

Text 2

Functions performed by the Financial System and the Financial Markets

The great importance of the financial system in our daily lives can be illustrated by reviewing its different functions. There are seven basic func­tions of the financial system in a modern economy.

Savings Function. As we noted earlier, the system of financial markets and institutions pro­vides a conduit for the public's savings. Bonds, stocks, deposits, and other financial claims sold in the money and capital markets provide a profit­able, relatively low-risk outlet for the public's savings. Those savings flow through the financial markets into investment so that more goods and services can be produced in the future, increasing society's standard of living. When savings flows decline, however, the growth of investment and living standards begin to fall.

Wealth Function. For those businesses and individuals choosing to save, the financial instru­ments sold in the money and capital markets provide an excellent way to store wealth (i.e., to preserve value) until funds are needed for spending in future periods. While we might choose to store our wealth in "things" (e.g., automobiles and clothes), such items are subject to depreciation and often carry great risk of loss. However, bonds, stocks, and other financial instru­ments do not wear out over time and usually generate income; and, nor­mally, the risk of loss is much less than for other forms of stored wealth.

Liquidity Function. For wealth that is stored in financial instruments, the financial market­place provides a means of converting those instruments into ready cash with little risk of loss. Thus, the financial system provides liquidity for savers holding financial instruments but in need of money. In modern so­cieties money consists mainly of deposits held in banks and is the only financial instrument possessing perfect liquidity. Money can be spent as it is without the necessity of converting it into some other form. However, money generally earns the lowest rate of return of all assets traded in the financial system, and its purchasing power is seriously eroded by inflation. That is why savers generally minimize their holdings of money and hold other financial instruments until spendable funds really are needed.

Credit Function.In addition to facilitating the flow of savings into investment and providing liquidity for stored wealth, the financial markets furnish credit to finance consumption and investment spending. Credit consists of a loan of funds in return for a promise of future payment. Consumers frequently need credit to purchase a home, buy groceries, repair the family automobile, and retire outstanding debt. Businesses draw upon their lines of credit to stock their shelves, construct buildings, meet payrolls, and grant divi­dends to their stockholders. State, local, and federal governments fre­quently borrow to construct buildings and other public facilities and cover daily cash expenses until tax revenues flow in.

Payments Function. The financial system also provides a mechanism for making payments for goods and services. Certain financial assets, mainly checking accounts and negotiable order of withdrawal (NOW) accounts, serve as a medium of ex­change in the making of payments. Plastic credit cards issued by many banks, credit unions, and retail stores give the customer instant access to short-term credit but also are widely accepted as a convenient means of payment. Plastic cards and electronic means of payment, including com­puter terminals in homes, offices, and stores, are likely to displace checks and other pieces of paper as the principal means of payment in the years ahead.

Risk Function. The financial markets offer businesses, consumers, and governments pro­tection against life, health, property, and income risks. This is accomplished first of all by the sale of life and property-casualty insurance policies. Pol­icies marketed by life insurance companies indemnify a family against possible loss of income following the death of a loved one. Property-casualty insurers protect their policyholders against an incredibly wide array of personal and property risks ranging from ill health, crime, and storm damage to negligence on the highways. In addition to making pos­sible the selling of insurance policies, the money and capital markets have been used increasingly by businesses and consumers to "self-insure" against risk. This simply means building up one's holdings of securities, deposits, and so forth, as a precaution against future loss.

Policy Function. Finally, in recent decades the financial markets have been the principal channel through which government has carried out its policy of attempt­ing to stabilize the economy and avoid excessive inflation.

Text 3

Fidelity Bonds, Surety Bonds, and Criminal Insurance

Two important types of insurance available to companies are called fidelity bonds and surety bonds. While many people think only of natural perils in connection with insurance, other unplanned losses can be insured. One such type of loss is due to theft and other criminal behaviors of employees.

Employees who are placed in positions of trust—especially positions that require handling money, such as cashiers, accountants, bartenders, and loan collectors—can embezzle or steal large sums of money from the company. Fidelity bonds protect employers against losses caused by dishonest and fraudulent acts of employees.

A second type of unplanned loss occurs when a company is unable to meet the perfor­mance terms of a contract. For example, a customer who asks a contractor to build a new warehouse may lose money if the warehouse is not completed by some specified date. In this case, the customer may ask the contractor to purchase a surety bond, a bond that provides monetary compensation if the bonded party fails to meet the performance terms of a contract. If the contractor fails to meet the completion deadline, the surety bond will compensate the customer for the face amount of the policy. Without the surety bond, the contractor might be obligated to compensate the customer directly.

A related type of insurance protects the company against the criminal acts of others. This is especially important in the case of burglary, robbery, and theft. Each of these perils requires a separate policy, because the risks differ and require different premiums. Burglary insurance covers losses when the company's property is taken by forced entry. If a "cat burglar" breaks into the premises at night and steals expensive display items, burglary insurance will cover the loss. Robbery insurance covers losses when the company's property is taken by force or threat of force, such as frequently happens during a holdup of a bank or convenience store. Theft insurance, which is general coverage, applies to all losses due to any act of stealing, including burglary and robbery. Note that employee theft may be covered by either fidelity bonds or theft insurance.

A very important group of insurance policies covers losses due to sickness, injuries, or deaths of employees. Partners may purchase life insurance policies that cover them for the unexpected death of one partner. In this section, however, we focus on insurance that provides benefits to employees and their survivors. This type of insurance, called employee benefit insurance, is for the benefit of employees and is intended to protect them rather than the com­pany in the event of fortuitous loss. Employee benefit insurance includes health insurance, life insurance, and annuities.

Health Insurance. The rising costs of health care have caused great concern for many Americans and their elected officials, including the Clinton administration. Although medical research has led to cures and treatments for many serious illnesses, the costs of treatments may be excessive. In addition to the direct cost of treatment, employees may lose wages and other benefits while they are sick. Health insurance is designed to cover losses suffered by employees due to illness or injury. These policies typically have a deductible amount which the employee pays when the loss occurs.

It is common for employers to provide group health insurance coverage for employees, in which employees pay part of the premium and the employer pays the other part. Health poli­cies typically cover hospital, surgical, and other common expenses. Major medical expenses, such as those for cancer treatment, are often covered by specific clauses in the policy. Many policies require coinsurance for some medical expenses, meaning the insured employee must pay a certain percentage of eligible medical expenses, such as 20 percent. In addition, certain costly, experimental medical treatments, such as bone marrow transplants, may be excluded.

Life insurance provides for payment of a stipulated sum to a designated ben­eficiary upon death of the insured. Life insurance is one of the most important investments wage earners can make for their dependents. As long as the primary wage earner is alive, the well-being of his or her family is reasonably safe. If the primary wage earner dies, however, the family survivors may be hard pressed to find financial support. Life insurance, especial­ly for the primary wage earner, is one of the basic means by which survivors can be assured of a reasonably comfortable lifestyle.

Social insurance programs are provided by government agencies and regulations. Generally, these programs are financed entirely by mandatory contributions from employers and / or employees rather than by general (tax) revenues. The contributions are set aside for the social insurance

Text 4

Mergers and Acquisitions

There is no more dramatic or controversial activity in corporate finance than the acquisition of one firm by another or the merger of two firms. The acquisition of one firm by another is, of course, an investment made under uncertainty. The basic principle of valuation applies: A firm should be acquired if it generates a positive net present value (NPV) to the shareholders of the acquiring firm.

There are three basic legal procedures that one firm can use to acquire another firm: (1) merger or consolidation, (2) acquisition of stock, and (3) acquisition of assets.

A merger refers to the absorption of one firm by another. The acquiring firm retains its name and its identity, and it acquires all of the assets and liabilities of the acquired firm. After a merger, the acquired firm ceases to exist as a separate business entity. A consolidation is the same as a merger except that an entirely new firm is creat­ed. In a consolidation, both the acquiring firm and the acquired firm terminate their previous legal existence and become part of the new firm. In a consolidation, the dis­tinction between the acquiring and the acquired firm is not important. However, the rules for mergers and consolidations are basically the same. Acquisitions by merger and consolidation result in combinations of the assets and liabilities of acquired and acquiring firms.

There are some advantages and some disadvantages to using a merger to acquire a firm:

1. A merger is legally straightforward and does not cost as much as other forms of acquisition. It avoids the necessity of transferring title of each individual asset of the acquired firm to the acquiring firm.

2. A merger must be approved by a vote of the stockholders of each firm. Typically, two thirds of the shares are required for approval. In addition, shareholders of the acquired firm have appraisal rights. This means that they can demand that their shares be purchased at a fair value by the acquiring firm. Often the acquiring firm and the dissenting shareholders of the acquired firm cannot agree on a fair value, which results in expensive legal proceedings.

The second way to acquire another firm is to purchase the firm's voting stock in exchange for cash, shares of stock, or other securities. This may start as a private offer from the management of one firm to another. At some point the offer is taken directly to the selling firm's stockholders. This can be accomplished by use of a tender offer. A tender offer is a public offer to buy shares of a target firm. It is made by one firm directly to the shareholders of another firm. The offer is communicated to the target firm's shareholders by public announcements such as newspaper advertisement. Sometimes a general mailing is used in a tender offer. However, a general mailing is very difficult because it requires the names and addresses of the stockholder record, which are not usually available.

One firm can acquire another firm by buying all of its assets. A formal vote of the shareholders of the selling firm is required. This approach to acquisition will avoid the potential problem of having minority shareholders, which can occur in an acquisition of stock. Acquisition of assets involves transferring title to assets. The legal process of transferring assets can be costly.

Financial analysts have typically classified acquisitions into three types:

1. Horizontal Acquisition. This is an acquisition of a firm in the same industry as the acquiring firm. The firms compete with each other in their product market.

2. Vertical Acquisition. A vertical acquisition involves firms at different steps of the production process. The acquisition by an airline company of a travel agency would be a vertical acquisition.

3. Conglomerate Acquisition. The acquiring firm and the acquired firm are not related to each other. The acquisition of a food-products firm by a computer firm would be considered a conglomerate acquisition.

Unit 7. Women in Business