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International financial module book
1. International Financial Module Book
Presented to: BBA-8
Presented by:
Muhammad Bilal (FA10-BBA-149)
Submitted to:
Sir WajidShakeel
Date: March 03, 2014
3. 1. INTRODUCTION:
Multinational Corporations are defined as firms that engage in some form of international
business. Their managers conduct international financial management, which involves
international investing and financing decisions that are intended to maximize the value of the
Multinational Corporations. Following are some elements due to which firm pursue
international business. These are
Comparative advantage theory; This theory stats that if a country has economy of scale in
a production of a product so she should produce only that product and should export it and
those products should be imported in which that country is not having economies of scale.
For example if a country A has economies of scale in the production in shirts and country B
has economies of scale in pants. So country A should export its shirts to country B and import
pants from country B.
Imperfect market theory; As economies of scale could be gained through factors of
production. So every country can import FOPs and can produce at low cost. But in real
world, it’s not like, here immobility of FOPs occurs. Which tells that FOPs are immobile and
can’t be transferred without any cost.
Product Cycle theory; The period of time over which an item is developed, brought to
market and eventually removed from the market. First, the idea for a product undergoes
research and development. If the idea is determined to be feasible and potentially profitable,
the product will be produced, marketed and rolled out. Assuming the product becomes
successful, its production will grow until the product becomes widely available. Eventually,
demand for the product will decline and it will become obsolete.
Following are some reasons why firms engage them in international businesses.
International Trade; is the exchange of capital, goods, and services across international
borders or territories.In most countries, such trade represents a significant share of gross
domestic product (GDP). While international trade has been present throughout much of
history (see Silk Road, Amber Road), it’s economic, social, and political importance has been
on the rise in recent centuries.
Industrialization, advanced in technology transportation, globalization, multinational
corporations, and outsourcing are all having a major impact on the international trade system.
Increasing international trade is crucial to the continuance of globalization. Without
4. international trade, nations would be limited to the goods and services produced within their
own borders.
Licencing; is the process of leasing a legally protected (that is, trademarked or copyrighted)
entity – a name, likeness, logo, trademark, graphic design, slogan, signature, character, or a
combination of several of these elements. The entity, known as the property or intellectual
property, is then used in conjunction with a product. Many major companies and the media
consider licensing a significant marketing tool.Licensing is a marketing and brand extension
tool that is widely used by everyone from major corporations to the smallest of small
business. Entertainment, sports and fashion are the areas of licensing that are most readily
apparent to consumers, but the business reaches into the worlds of corporate brands, art,
publishing, colleges and universities and non-profit groups, to name a few.Licensing can
extend a corporate brand into new categories, areas of a store, or into new stores overall.
Licensing is a way to move a brand into new businesses without making a major investment
in new manufacturing processes, machinery or facilities. In a well-run licensing program, the
property owner maintains control over the brand image and how it's portrayed (via the
approvals process and other contractual strictures), but eventually reaps the benefit in
additional revenue (royalties), but also in exposure in new channels or store aisles.
Franchising is a business model in which many different owners share a single brand name.
A parent company allows entrepreneurs to use the company's strategies and trademarks; in
exchange, the franchisee pays an initial fee and royalties based on revenues. The parent
company also provides the franchisee with support, including advertising and training, as part
of the franchising agreement.Franchising is a faster, cheaper form of expansion than adding
company-owned stores, because it costs the parent company much less when new stores are
owned and operated by a third party. On the flip side, potential for revenue growth is more
limited because the parent company will only earn a percentage of the earnings from each
new store. 70 different industries use the franchising business model, and according to the
International Franchising Association the sector earns more than $1.5 trillion in revenues
each year.
Joint venture;A business arrangement in which two or more parties agree to pool their
resources for the purpose of accomplishing a specific task. This task can be a new project or
any other business activity. In a joint venture (JV), each of the participants is responsible for
profits, losses and costs associated with it
5. Acquisition;A corporate action in which a company buys most, if not all, of the target
company's ownership stakes in order to assume control of the target firm. There's only one
real way to achieve massive growth literally overnight, and that's by buying somebody else's
company. Acquisition has become one of the most popular ways to grow today.
1.2 Conclusion;In this chapter it is discussed that how companies do their operations
internationally and how do they compete internationally, also what are the reasons and ways
of how they acquire other companies competing globally.
1.3 Assignment
Volatility and misalignmentIn finance, volatility is a measure for variation of price of a
financial instrument over time. Historic volatility is derived from time series of past market
prices
MisalignmentIt refers to a significant deviation of the actual real exchange rate from its
equilibrium level.
Historical perspective of Euro market.In January 1st
, 1999, 11 countries formed EEMU
(European economic monitory union). They formally left their currency and opt Euro.
Number of recent papers argues that formation of EEMU has great impact on country’s
international trade pattern. Some said that countries who have opt Euro, trade increased by 4-
16%. Introduction of Euro has positive significant effect on intra-EMU, trade has attracted
considerable attention. If common currency boosts trade even in highly integrated economies,
currency union becomes more attractive. As a result, countries that are currently considering
joining Euro may choose for early adoption of Euro.
Currency convertibility. It’s an ease of the conversion of country’s currency into gold or
other currency. Convertibility is very important in international trade or commerce. If a
country’s currency is inconvertible, it creates risk and barrio to trade with foreigners.
6. Birth of European international community. The "birth" of the European Union as the
world knows it today occurred with the creation of the European Coal and Steel Community
in 1951. In this sense, the European Union arose from the ashes of World War II. The modem
history of European integration commences with the end of the Second World War in
Europe, in May 1945, with calls emanating from resistance fighters and governments in exile
for an integrated Europe.9 Modem European integration, leading to the European Union, is
generally agreed to have been born with the dramatic declaration of French Foreign Minister
Robert Schuman of May 9, 1950. This declaration was largely the work of French senior civil
servant Jean Monnet, who headed up the planning office responsible for French economic
reconstruction. In his remarks to a press conference called for the occasion, Schuman
proposed the creation of a European Coal and Steel Community (ECSC). The ECSC would
pool the resources of the French and German coal and steel industries (the traditional
industries of war), and place them under a supranational High Authority. Other European
nations were invited to join. It is impossible to list all of the significant events leading up to
the announcement of the Schuman Plan. Churchill's 1946 Zurich speech could be perceived
as a strong British commitment to creating a federal, or supranational, Europe. On the other
side of the Atlantic, on March 12, 1947, U.S. President Harry Truman, in an address to the
joint houses of Congress, committed the American people to providing financial and other
assistance "essential to economic stability and orderly political processes.
International debt settlement market. The term financial crisis is applied broadly to a
variety of situations in which some financial assets suddenly lose a large part of their nominal
value. In the 19th and early 20th centuries, many financial crises were associated with
banking panics, and many recessions coincided with these panics. Other situations that are
often called financial crises include stock market crashes and the bursting of other financial
bubbles, currency crises, and sovereign defaults. Financial crises directly result in a loss of
paper wealth but do not necessarily result in changes in the real economy. Many economists
have offered theories about how financial crises develop and how they could be prevented.
There is no consensus, however, and financial crises continue to occur from time to time.
8. 2. INTRODUCTION
International business is facilitated by markets that allow for the flow of funds between
countries. The transactions arising from international business cause money flows from one
country to another. The balance of payments is a measure of international money flows and is
discussed in this chapter
Balance of payments; Thebalance of payments is a measurement of all transactions between
domestic and foreign residents over a specified period of time. Each transaction is recorded
as both a credit and a debit. The transactions are presented in three groups i.e. a current
account, a capital account, and a financial account. There are three main components of
current account i.e. Payment for merchandise and services, Factor income payments, and
Transfer payments.
Payment for merchandise and services includes the imports and exports of merchandised
goods and services of one country with the rest of the world. The difference between exports
and imports is known as balance of trade. The current account is commonly used to assess the
balance of trade. Factor Income Payments is second component of the current account
which represents income includes interest and dividend which investors received on foreign
investment in financial assets or securities. Transfer payments refer to aids, grants, and gifts
from one country to another. A current account deficit suggests a greater outflow of funds
from the specified country for its currenttransactions. Capital account includes unilateral
current transfers that are really shifts in assets, not current income. E.g. debt forgiveness,
transfers by immigrants, the sale or purchase of rights to natural resources or patents. Three
main elements of financial account include direct foreign investment, Portfolio investment,
and other capital investments.
Direct foreign investment shows the investment in fixed assets in foreign countries that is
used to conduct business operations. Examples could be like when a firm acquires a foreign
company, construction of a new manufacturing plant, or expansion of existing business in a
foreign country. Portfolio Investment represents transactions that involve long-term
financial assets such as stocks and bonds between countries and which do not affect the
transfer of control means without changing the control of the company. Other capital
investments include transactions involved short-term financial assets such as money market
securities between countries. If current account is registered as surplus as compare to smaller
surplus to capital account then it would be a surplus as a whole and vice-versa for the deficit.
9. International trade flows; In 1998, a 1989 free trade pact between U.S. and Canada was
fully phased in. In 1993, the North American Free Trade Agreement (NAFTA) removes
numerous trade restrictions among Canada, Mexico, and the U.S. In 2001, trade negotiations
were initiated for a free trade area of the Americas in which 34 countries are involved. The
Single European Act of 1987 was implemented to remove explicit and implicit trade barriers
among European countries. Consumers in Eastern Europe now have more freedom to
purchase imported goods. The single currency system implemented in 1999 eliminated the
need to convert currencies among participating countries. In 1993, a General Agreement on
Tariffs and Trade (GATT) accord calling for lower tariffs was made among 117 countries.
Other trade agreements include Association of Southeast Asian Nations, European
Community, Central American Common Market, and North American Free Trade
Agreement.
Trade friction; These are the barriers of trade which includes such as Trade agreements are
sometimes broken when one country is harmed by another country’s actions. Dumping is one
of the activity refers to trade restrictions which means the exporting of products by one
country to other countries at prices below cost. Another situation that can break a trade
agreement is copyright piracy. Another could be like using the exchange rate as a policy in
which a group of exporters can claim that they are being mistreated and force their
government to adjust the currency so that their exports will not be so expensive for foreign
purchasers. Outsourcing of services from foreign countries creates employment issues
domestically which is criticized by the people domestically and restricts trade in some way.
Factors affecting international trade flows
The most significant factors that influence trade flows are:
Inflation; A relative increase in a country’s inflation rate will decrease its current account, as
imports increase and exports decrease.
National Income; A relative increase in a country’s income level will decrease its current
account, as imports increase.
10. Government Restrictions; A government may reduce its country’s imports by imposing
tariffs on imported goods, or by enforcing a quota. Note that other countries may react by
imposing their own trade restrictions. Sometimes though, trade restrictions may be imposed
on certain products for health and safety reasons.
Exchange Rates; If a country’s currency value begins to rise, its current account balance will
decrease as imports increase and exports decrease.
Interaction of Factors; Factors that affect balance of trade interact as when inflation in a
country rises, it results in reduction in current account in Balance of payment. On the other
hand decrease in the value of currency would be there which results in increase in the demand
by foreign customers and will increase in exports, so ultimately an increase in current account
would be there.
Correcting a balance of trade deficit: A floating exchange rate system may correct a trade
imbalance automatically since the trade imbalance will affect the demand and supply of the
currencies involved. As when deficit is there in a country’s balance of trade the value of its
currency should decrease because it is selling its currency to buy foreign goods. So, this
decrease in value will create more foreign demand for its goods. However, a weak home
currency may not necessarily improve a trade deficit. Foreign companies may lower their
prices to maintain their competitiveness. Some other currencies may weaken too. Many trade
transactions are prearranged and cannot be adjusted immediately and is known as the J-curve
effect.
International capital flows: Capital flows usually represent portfolio investment or direct
foreign investment. Specially, both DFI positions increased during periods of strong
economic growth.
Factors affecting FDI
Changes in Restrictions: New opportunities may arise from the removal of
government barriers.
Privatization: Direct Foreign Investment has also been encouraged by the selling of
government operations.
Potential Economic Growth: Countries with higher potential economic growth are
more likely to attract Direct Foreign Investment.
11. Tax Rates: Countries that impose relatively low tax rates on corporate earnings are
more likely to attract Direct Foreign Investment.
Exchange Rates: Firms will usually have a preference to invest their reserves in a
country when that country’s currency is expected to strengthen in the value of their
currency.
Factors affecting international portfolio investment
Tax Rates on Interest or Dividends: Investors will normally prefer countries where the
tax rates on interest or dividends are comparatively low.
Interest Rates: Money tends to flow to countries with high interest rates. It is usually
very normal that every individual who wants to invest some money will prefer to have
more interest rate in return.
Exchange Rates: Foreign investors may be attracted if the local currency is expected
to strengthen.
13. 3. INTRODUCTION:
The basic purpose of this chapter is to describe the background and corporate use of the
following international financial markets, foreign exchange market,Eurocurrency
market,Eurocredit market,Eurobond market, andinternational stock markets.
Foreign Exchange Market: The markets in which participants are able to buy, sell,
exchange and speculate on currencies. Foreign exchange markets are made up of banks,
commercial companies, central banks, investment management firms, hedge funds, and retail
forex brokers and investors. The forex market is considered to be the largest financial market
in the world. Because the currency markets are large and liquid, they are believed to be the
most efficient financial markets. It is important to realize that the foreign exchange market is
not a single exchange, but is constructed of a global network of computers that connects
participants from all parts of the world.
Foreign Exchange transaction: In general terms foreign exchange is the conversion of one
currency to another at an agreed exchange rate. An FET is a binding agreement between you
and WUBS in which one currency is sold or bought against another currency at an agreed
exchange rate on the current date or at a specified future date. The day that you order your
currency is referred to as the Trade Date; the day that you are required to make payment for
your currency (and the day that we exchange currencies) is referred to as the Value Date
WUBS offers the following three types of FETs:
In addition to these FET’s we also offer foreign exchange products that are settled beyond
two business days. These are referred to as Forward Exchange Contracts, Vanilla Foreign
Exchange Options and Structured Foreign Exchange Options. Separate Product Disclosure
Statements are available for each of these products.
Foreign exchange Quotation and its interpretation
Direct Quote: A foreign exchange rate quoted as the domestic currency per unit of the
foreign currency. In other words, it involves quoting in fixed units of foreign currency against
variable amounts of the domestic currency. For example, in the U.S., a direct quote for the
Canadian dollar would be US$0.85 = C$1. Conversely, in Canada, a direct quote for U.S.
dollars would be C$1.17 = US$1.
14. Indirect Quote:A currency quotation in the foreign exchange markets that expresses the
amount of foreign currency required to buy or sell one unit of the domestic currency. An
indirect quote is also known as a “quantity quotation,” since it expresses the quantity of
foreign currency required to buy units of the domestic currency. In other words, the domestic
currency is the base currency in an indirect quote, while the foreign currency is the counter
currency. An indirect quote is the opposite or reciprocal of a direct quote, also known as a
“price quotation,” since it expresses the price of one unit of a foreign currency in terms of the
domestic currency.
As the US dollar is the dominant currency in global foreign exchange markets, the
convention is to generally use direct quotes that have the US dollar as the base currency and
other currencies – like the Canadian dollar, Japanese yen and Indian rupee – as the counter
currency. Exceptions to this rule are the euro and Commonwealth currencies like the British
pound, Australian dollar and New Zealand dollar, which are typically quoted in indirect form
(for example GBP 1 = USD1.50). Consider the example of the Canadian dollar (C$), which
we assume is trading at 1.0400 to the US dollar. In Canada, the indirect form of this quote
would be C$1 = US$0.9615 (i.e. 1/1.0400).
Cross Exchange Rate: The currency exchange rate between two currencies, both of which
are not the official currencies of the country in which the exchange rate quote is given in.
This phrase is also sometimes used to refer to currency quotes which do not involve the U.S.
dollar, regardless of which country the quote is provided in. For example, if an exchange rate
between the Euro and the Japanese Yen was quoted in an American newspaper, this would be
considered a cross rate in this context, because neither the euro or the yen is the standard
currency of the U.S. However, if the exchange rate between the euro and the U.S. dollar were
quoted in that same newspaper, it would not be considered a cross rate because the quote
involves the U.S. official currency.
3.1Conclusion
This chapter tells about how countries convert their currencies thorough cross exchange rates.
Assignment
1987 STOCK MARKET CRASH
15. Introduction
Till August 1987 markets were favourable. If truth be told as per the records of twenty fifth
August 1987, the Dow was of a 2722.44, that was virtually a record hike. However afterward
it solely began to depreciate. An 8.4% drop was recorded on Sep twenty second 1987. Then
{again} there was a rise of Dow again. A 5.9% increase was recorded on the 2d of Gregorian
calendar month 1987. However that was just for the present. Yet again the Dow began to fall
and by Gregorian calendar month nineteenth the market had badly crashed; such a lot in order
that the Dow had born to 508. That might be virtually a twenty two.6% drop on it single day.
And if the drop had to be measured from the height on twenty fifth August, it absolutely was
a walloping thirty six.7%. Gregorian calendar month nineteenth has since been brought up
because the Black weekday. The 1987 crash was therefore massive that the securities market
all over up losing virtually $1/2 trillion. Currently what might be the probable reason for such
AN unnatural crash within the stock market? Market analysts over the years have deduced the
explanations that may have resulted during this market crash. The primary and foremost
reason they seen was that the market lacked liquidity. The market did not manage the sudden
and intensely high volume of sell orders. It appeared that nearly all the investors required to
sell their stocks at that exact time. This became troublesome for the market to handle and
resulted within the crash
Causes of crash: One of the various reasons that resulted within the crash of 1929 is that the
over valuation of the stocks. The mercantilism of the stocks at that time of your time was
being disbursed at a really high P/E ratio. High P/E ratios don't end in a securities market
crash each time. This may be understood from the very fact that even throughout the years
1960-1972; the stocks were being listed at high P/E ratios. However at that point no such
crash within the securities market happened. Market Analysts WHO researched on supposed
reasons for the crash of 1987 conjointly believe that pc mercantilism and security of
derivatives could be a major cause that resulted within the historical crash. Giant the
massive} investment firms ordered very large stock trades through computers. This
conjointly served to be a reason for the massive securities market crash.
Changes after crash: Now started the preparations for reforms to revive the market and pull
it out from the massive crisis. The primary and foremost reform that was advised was the
uniformity of the margin necessities. This was done in order that the volatility of the stocks,
16. stock choices and index options can be reduced. Conjointly the installation of latest laptop
systems was advised in order that the market can be force out from these troublesome times
as before long as attainable. These laptop systems that were fresh put in within the stock
exchanges required simply one key stroke to enter the trade. Earlier this work would be slow
and required virtually twenty five keystrokes. These new laptop systems rejected the trade if
a wrong input was created. That ways in which these computers helped increase the potency
of information management. They conjointly helped to attenuate errors and maximize
productivity. Overall these new laptop systems were serving to manage the info with a lot of
ease decreasing probabilities of mistakes to an excellent extent.
Following the 1987 securities market crash was one in all the key reforms that were
introduced was by the Chicago Mercantile Exchange and therefore the New York Stock
Exchange. They along introduced the revolutionary “circuit breaker” mechanism. This
method was put in in these 2 exchanges thereto no major market crashes any occurred. What
this mechanism did was halt the market just in case of major fall of the Dow. Throughout this
era no trade can be administered in these 2 exchanges. If the Dow fell 250 points or a lot of,
the market would stop its commercialism for associate hour. If the autumn had been for quite
four hundred points then the market would halt for 2 hours.
Outcomes: The 1987 stock exchange Crash was extremely large and resulted in ample
individuals to loose wealth. The reforms that were introduced required to be strictly followed
so the market might pass though the losses shortly. Until date the 1987 stock exchange crash
is mentioned to be one among worst crashes within the history of stock commerce. Once the
1929 stock exchange crash this was the most important crash to occur leading to an enormous
loss.
18. 4.1 INTRODUCTION:
Measuring exchange rates movements: An exchange rate measures the value of one
currency in units of another currency. When a currency declines in value, it is said to
depreciate. When it increases in value, it is said to appreciate. On the days when some
currencies appreciate while others depreciate against the dollar, the dollar is said to be
“mixed in trading.”
The percentage change in the value of a foreign currency is computed as
St – St-1/St-1
St denotes the spot rate at time t.
A positive % change represents appreciation of the foreign currency, while a negative %
change represents depreciation.
Exchange rate equilibrium:An exchange rate represents the price of a currency, which is
determined by the demand for that currency relative to the supply for that currency.
Impact of Liquidity: The liquidity of a currency affects the sensitivity of the exchange rate
to specific transactions. If the currency’s spot market is liquid, its exchange rate will not be
highly sensitive to a single large purchase or sale of the currency. So, the change in
equilibrium exchange rate will be relatively small. With many willing buyers and sellers of
the currency, transactions can be easily accommodated. And vice-versa if the currency is
illiquid.
Factors that influence exchange rate: The equilibrium exchange rate changes ever time as
demand and supply schedules change. The following equation summarizes the factors that
can influence a currency’s spot rate:
e = f (∆INF, ∆INT, ∆INC, ∆EXP)
19. Relative Inflation Rates
Domestic inflation rate is high.
Domestic demand for foreign goods would become high.
Demand for foreign goods and foreign currency would be high.
Supply for foreign currency would get decrease.
Relative Interest Rates
Domestic interest rate is high as compare to foreign interest rate.
Capital flows (outflows) of foreign assets into domestic assets.
FOREX market: Demand for foreign currency or goods and services would get decrease and
supply increase.
A relatively high interest rate may actually reflect expectations of relatively high inflation,
which discourages foreign investment. It is thus useful to consider real interest rates, which
adjust the nominal interest rates for inflation.
Real interest rate = Nominal interest rate – Inflation rate
This relationship is sometimes called the Fisher effect.
20. Relative Income Levels
Domestic income increases.
Foreign imports grow faster than exports.
Demand for foreign goods and ultimately currency would be greater than supply.
Demand for domestic currency would get decline.
Government Controls
Imposing foreign exchange barriers.
Imposing foreign trade barriers.
Intervening in the foreign exchange market.
Affecting macro variables such as inflation, interest rates, and income levels.
Expectations
Foreign exchange markets react to any news that may have a future effect.
Institutional investors often take currency positions based on anticipated interest rate
movements in various countries.
Because of speculative transactions, foreign exchange rates can be very volatile.
4.2 Conclusion
21. 4.3 Assignment
Great Depression 1929
Capital is that the tools required to supply things valuable out of raw materials. Buildings and
machines area unit common samples of capital. A factory could be a building with machines
for creating valued merchandise. Throughout the 20th
century, most of the capital within the
US was delineated by stocks. An organization in hand capital. Possession of the corporation
in turn took the shape of shares of stock. Every share of stock delineated a proportionate
share of the corporation. The stocks were bought and oversubscribed on stock exchanges, of
that the foremost vital was the big apple securities market settled on Wall Street in
Manhattan. Throughout the Twenties a protracted boom took stock costs to peaks ne'er before
seen. From 1920 to 1929 stocks quite quadrupled in price. Several investors became
convinced that stocks were a certainty and borrowed heavily to take a position more cash
within the market.
But in 1929, the bubble burst and stocks started down a fair a lot of precipitous drop. In 1932
and 1933, they hit bottom, down concerning eightieth from their highs within the late
Twenties. This had sharp effects on the economy. Demand for merchandise declined as a
result of individuals felt poor thanks to their losses within the securities market. New
investment couldn't be supported through the sale of stock, as a result of nobody would
obtain the new stock. But maybe the foremost vital impact was chaos within the industry as
banks tried to gather on loans created to stock market investors whose holdings were
currently price very little or nothing the least bit. Worse, several banks had themselves
invested with depositors' cash within the stock market. Once word unfold that banks' assets
contained vast uncollectable loans and virtually rubbishy stock certificates, depositors rush to
withdraw their savings. Unable to lift contemporary funds from the Federal Reserve System,
banks began failing by the whole lot in 1932 and 1933.
By the inauguration of Franklin D. Roosevelt as president in March 1933, the industry of the
US had for the most part ceased to operate. Depositors had seen $140 billion disappear once
their banks unsuccessful. Businesses couldn't get credit for inventory. Checks couldn't be
used for payments as a result of nobody knew that checks were rubbishy and that were sound.
Roosevelt closed all the banks within the US for 3 days - a "bank vacation." Some banks
were then cautiously re-opened with strict limits on withdrawals. Eventually, confidence
22. came back to the system and banks were able to perform their economic operate once more.
To stop similar disasters, the centralized discovered the Federal Deposit Insurance
Corporation that eliminated the explanation for bank "runs" - to urge one's cash before the
bank "runs out." Backed by the FDIC, the bank may fail and withdraw of business, on the
other hand the government would reimburse depositors. Another crucial mechanism insulated
industrial banks from securities market panics by forbiddance banks from investment
depositors' cash in stocks.
