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Impact of Global Financial Crisis 2008 on Automobile Industry

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Abstract

Global financial crisis has formed bad impact on automobile industry in USA, like Suziki, Hyundai and Honda from 2008-2010. The companies' sale decreased because of market situation and slum in world economy. Now economic conditions are getting better by having good financial policies and market exposure. This research study will explain the importance of debt to equity ratio in term of risk exposure being taken by the firm in market to finance the business and also analyze the importance and effectiveness of debt to equity for automobile sector. This study is based upon the three major players of industry to signify the risk exposure in term of debt and equity during a period of financial crisis and then how they manage it while looking at international financial regulations accordingly. Suzuki overcame this situation by keeping focus on R & D, marketing and manufacturing units. It has also changed its exposure of debt to equity, in the meantime of financial crisis it is having more financing through common stock. Hyundai overcame this situation by focusing on stakeholders like customers and employees. And due to this strategy the crisis has created the low effects on the Hyundai profitability and sales. The Honda after the recession they began to again paying keen attention on its performance and increased its sales by introducing the innovation in its different models by launching the hybrid fuel efficient models. And it also keeps on focusing common stock rather than lending from risky source. It also explained the role of Federal Reserve Bank to control financial crisis all over the world. In the end this paper will compare the market exposure of debt and equity of three companies and suggest some recommendations to be more secure in future if same crisis revert again.
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Impact of Global Financial Crisis 2008 on Automobile Industry
Farman Afzal
1
Fahim Afzal
2
Shoaib Masood Khan
3
Muhammad Sajid
4*
1. Lecturer, Institute of Business and Management, UET Lahore, Pakistan
2. Bahauddin Zakariya University (Sahiwal Campus), Pakistan
3. PhD Scholar, COMSATS Institute of Information Technology, Islamabad, Pakistan
4. Lecturer, Department of Management Sciences and Commerce, Mohi-Ud-Din Islamic University Nerian
Shaif, AJ&K, Pakistan
* E-mail of the corresponding author: chsajid_24@yahoo.com, Tel: 00923146160441
Abstract
Global financial crisis has formed bad impact on automobile industry in USA, like Suziki, Hyundai and Honda from
2008-2010. The companies’ sale decreased because of market situation and slum in world economy. Now economic
conditions are getting better by having good financial policies and market exposure. This research study will explain
the importance of debt to equity ratio in term of risk exposure being taken by the firm in market to finance the
business and also analyze the importance and effectiveness of debt to equity for automobile sector. This study is
based upon the three major players of industry to signify the risk exposure in term of debt and equity during a period
of financial crisis and then how they manage it while looking at international financial regulations accordingly.
Suzuki overcame this situation by keeping focus on R & D, marketing and manufacturing units. It has also changed
its exposure of debt to equity, in the meantime of financial crisis it is having more financing through common stock.
Hyundai overcame this situation by focusing on stakeholders like customers and employees. And due to this strategy
the crisis has created the low effects on the Hyundai profitability and sales. The Honda after the recession they
began to again paying keen attention on its performance and increased its sales by introducing the innovation in its
different models by launching the hybrid fuel efficient models. And it also keeps on focusing common stock rather
than lending from risky source. It also explained the role of Federal Reserve Bank to control financial crisis all over
the world. In the end this paper will compare the market exposure of debt and equity of three companies and suggest
some recommendations to be more secure in future if same crisis revert again.
Keywords: Financial Crisis, Automobile Sector, Debt-to-Equity Ratio, Federal Reserve Bank.
Paper Type: Research Paper
1. Introduction
Global economic crisis started in December 2007 and took a sharp down turn in September 2008. That great crisis
has affected the whole world’s economy, with great harms in different countries. This recession separated into two
senses of the word "recession": a less precise sense, referring broadly to an era that reduces the activities of the
economy " because unemployment, inflation increases so the buying power of the buyers decreases and another
sense is the scientific that used most frequently in economics, which is defined operationally, it refers specifically to
the decline phase of a business cycle, increase in raw material prices and the fuel prices increase.
The automobile industry become very weak due to increase in the prices of fuel which is also cause to discouraged
the purchases of sport utility vehicles (SUVs) and pickup trucks which have low fuel economy. The reputation and
high profit margins of these vehicles has positively influence the American "Big Three" automakers, General
Motors, Ford, and Chrysler to make them their primary focus, with fewer fuel-efficient models to offer to consumers,
sales began to slide.
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Car production trend all over the world is:
0
10,000,000
20,000,000
30,000,000
40,000,000
50,000,000
60,000,000
70,000,000
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
Cars Produced in The World
Cars Produced in The World
Year Cars Produced in The World
2011 59,929,016
2010 58,264,852
2009 47,772,598
2008 52,726,117
2007 53,201,346
2006 49,918,578
2005 46,862,978
2004 44,554,268
2003 41,968,666
2002 41,358,394
2001 39,825,888
2000 41,215,653
1999 39,759,847
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Car companies from Asia, Europe, North America, and in another place have implemented creative marketing
strategies to attract unwilling consumers. In that era there is double digit decline in sales. In December, American
automobile manufacturers sustained at 32 percent Ford and 31 per cent for General Motors. And Japanese demand
also diminishes by 38% reported in February 2008 (Tom Krisher (2008). Suzuki decreased the sales in those years by
21.97% and Honda decreased its sales by 13.72%, But Honda follow the strategy to offer fuel efficient models to
boost up the sale and to survive in the recession, just two models of Honda posted positive trend for the month means
boost up the sale of Honda; the fuel efficient Honda Fit and the new for 2009 Acura TSX. Due to more decline in
sales of Japanese market and companies faces the heavy loss, by considering this Japanese government planned to
offer the bailout package $5 billion through semi-governmental organizations, Honda require bailout only $100
million due to its fuel efficient models because they boost up the sales of Honda (Sturgeon, 2010).
2. Background Information about the Companies
SUZUKI
The Suzuki Company was founded in 1909 by Michio Suzuki as the Suzuki Loom Works. With the success in looms
for more than 3 decades, Suzuki diversified its potential to other products. In 1937, the company decided to make
small cars as per consumer demand. In 1955, “the Suzulight”; the debut car was introduced after several years of
Suzuki’s research and development. In the beginning of the 1960s, Suzuki introduced a new model, the “Suzulight
Carry” to its light weight cars family. In the 1960’s decade, “Suzuki Fronte 800” and “Carry Van” were also
introduced to extend the brand’s product line. In the beginning of 1970s, the brand introduced a new four wheel drive
model, named “Jimmy.” At the end of the 1970’s decade, Suzuki became popular in the middle class consumers and
its production also increased.
In 1980, General Motors took 5 percent of Suzuki stakes to get into more business and the small vehicle of this
Japanese automaker became very popular in the American market. This joint venture lent General Motors the chance
to sell Suzuki vehicles in the United States. In the middle of the 1980s, Suzuki established its American station and
introduced its vehicles with its own brand. Suzuki “Samurai” was crowned as the first vehicle introduced, a compact
SUV available with soft and hard tops. Suzuki’s struggle for production went on and it launched its new models
“Swift” and the “Sidekick” SUV.With the passage of time, Suzuki focused to expand exports and its market scope. In
0
10,000,000
20,000,000
30,000,000
40,000,000
50,000,000
60,000,000
70,000,000
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
Cars Produced in The World
Cars Produced in The World
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the beginning of the 1990s, Suzuki reached to the South African, European, and South Asian countries. Soon the
brand introduced its new vehicles the Esteem, the X-90, “Vitara” and “Grand Vitara” models as a replacement for
Samurai and Sidekick.In the year 2004, GM and Suzuki acquired the struggling Daewoo, and in a short time Suzuki
introduced its two new models Suzuki “Forenze” and “Verona.” Both vehicles were a rebadged version of Daewoo
models.(
Suzuki Motor, 2010
)
HYUNDAI
Hyundai Motor Co. was established in Korea in 1967. The company’s first model (Cotina) was released, in
cooperation with Ford Motor Company, in 1968. In 1998, Hyundai acquired a 51% stake in KIA, but has since
reduced its share to 37%. In 2004, Hyundai was South Korea’s largest car maker and the world’s seventh largest car
maker selling 2.3 million units. Hyundai currently offers about a dozen cars and minivans, as well as trucks, buses,
and other commercial vehicles. Some popular entries in their product lineup include the Accent, Sonata, Tucson,
Elantra, Santa Fe, and Tiburon, which all earned the title “Best Bet” in Jack Gillis’ The Car Book 2005. Hyundai’s
parent reflecting this trend of low prices and increased market share, in 2004 Hyundai reported a dramatic increase in
annual revenues to 50.7 billion dollars and only a small gain in net income to 1.78 billion dollars.
Hyundai’s growth is fueled by increasing international sales. From January-September 2005, sales in Russia
increased 100% and sales in the U.S. increased 10% year-on-year. To meet this new demand, Hyundai has been
investing in manufacturing plants in North America, India, China, Turkey and research and development centers in
North America, Japan and Europe. In June 2004, Hyundai opened its first plant in the U.S. In 2006, Hyundai plans to
start construction on a new production plant in Europe.
HONDA
Honda Motor Co. was established in 1946. It originally began producing motorcycles in the mid-20th century and
began manufacturing automobiles in 1972.After the original Civics’ launch; Honda produced many variants of this
highly successful vehicle, such as the four-door sedan, wagons, hatchback, coupe, and more recently the hybrid.
Honda currently has two automotive brands (Honda and Acura) and it produces over 20 other vehicle models, such
as the Accord, Element, Insight, Odyssey Minivan, Pilot SUV, and Ridgeline Truck, in addition to producing
motorcycles and power products. In 1977 and 1983, Civic models ranked first in U.S. fuel-economy tests. Honda
has also introduced hybrid vehicles such as the Insight, Civic, and Accord, in 1999, 2002, and 2004, respectively,
with the 2006 Insight being the most fuel efficient car of 2006.
Currently, Honda ranks sixth in sales within the automotive industry. They have overseas plants in over 12 countries
including the U.K., Italy, Brazil, Taiwan, Indonesia, Malaysia, Thailand, Nigeria, U.S., and Canada. Honda has been
increasing their production capacity worldwide in response to their steady growth in total sales over the last few
years. From 2002 to 2003, Honda increased sales by 95,000 units, and from 2003 to 2004, sales increased by 259,000
units. In China, they saw approximately a 50% increase in sales from the fiscal years of 2003 to 2004, and they
expect sales to keep increasing. In the future, Honda has stated that they will keep improving the fuel efficiency of
all their vehicles. They will continue to expand their production capacity in Asia, due to the expected increases in
demand in those regions.
3. Literature Review
Debt to equity measures how much debt a company has compared to its equity. That means it looks at how much the
company owes and divides it by the firm's equity. (Equity is just the opposite of debt -- it is ownership, including
shares of stock in a corporation). To state it another way, the ratio compares long-term funds provided by creditors
with funds provided by owners -- what a company owes versus the amount of money it has invested in it. It indicates
what portion or percentage of equity and what portion or percentage of debt the company is using to finance its
business. (
Reeve, 2012
)
Lot of research studies have been conducted on the issue of capital structure. The first scientific study conducted in
the field of capital structure is of Franco Modigliani and Merton Miller (1958). In their study, on the basis of certain
unrealistic assumptions like zero taxes, they concluded that a firm’s value is unaffected by the level of debt used. In
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their second article in 1963, MM considered the corporate taxes and concluded that due to tax deductibility of
interest; the use of debt increases the value of the firm. So the firms can use 100% debt.
A high debt/equity ratio means that the company has been "aggressive" in financing its growth with debt and that it is
carrying a sizable amount of interest expense.A ratio greater than 1 means assets are mainly financed with debt; ratio
less than one means equity provides the majority of the financing. “Debt financing is more risky than equity
financing because debt must be repaid at specific points in time, whether the company is performing well or not.
Thus, higher the percentage of debt financing, the riskier the company would be”(
Peterson, 1999).
Debt to equity ratio is pretty important to a firm during a crisis time when businesses face low growth and high cost
element in its financial performance. J.H.Boyd explained the situation wher MNCs have to manage their financial
ratio while looking at the market exposure in term of financial risk. He also discussed the ideal combination of debt
to equity ratio of firm at the time of crisis. And suggested that firms need to rely on common stock rather than to
have lending from banks at the time of crisis. Even though common stock in expensive but it provides a shelter not to
be bankrupt on their financial exposure. (J.H.Boyd, 1998)
4. Results and Discussions
SUZUKI - Debt to Equity Ratio (Amount in 000)
Item 2010 2009 2008 2007 2006
Total Liabilities(A) 13,881,738 14,404,298 15,034,138 12,413,962 6,114,043
Equity (B) 11,030,223 7,653,592 7,547,781 5,773,011 9,213,791
Debt-to-equity
Ratio=A/B(times) 1.26 1.88 1.99 2.15 0.66
In 2006 the company is showing its good performance because its equity is more than its total liability. The company
1.26
1.88 1.99
2.15
0.66
0
0.5
1
1.5
2
2.5
2010 2009 2008 2007 2006
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has more ability to pay its debts. Low debt-to-equity ratios may also indicate that a company is not taking advantage
of the increased profits that may bring financial leverage. They are generating their liabilities through secured and
unsecured loans. SUZUKI has completed the construction of a new manufacturing plant near Delhi in India, in which
the SUZUKI has 74% share. In 2006 the SUZUKI’s sales in Europe increased by 16% by capturing 2% market share.
This all achievements are due to launching of new production in the market according to the changing needs of the
customers. Suzuki gives special importance to its R&D in order to become the market champion. In 2007 the debt
equity ratio is maximum as compare to other years, its liabilities are almost 100% increased. Here a lot of debt
is used to finance increased operations; the company could potentially generate more earnings than it would have
without this outside financing. The short term bank loans are $1,416,657 in which the secured loan is $6223 and
unsecured is $1,410,433 in this year there is major increase as compare to previous year 2006. In 2007 the long term
debt is $2,018,706which is 69% more than the previous year. Capital-intensive industries tend to have higher debt-to-
equity ratios. In late 2007 the global economic crisis has been started and the company is taking measures in order to
prevent from the bad effects of such crisis, because this crisis has increase the overall prices such as raw material,
fuel etc. in order to cover the cost and to maintain their sales level they started to generate its liabilities up to 100%
as compared to previous year. In 2008 there equity is increased approximately with same proportion of debts,
because the company wants to earn profit and to stabilize their position in the market. High debt to equity ratio
increased the earnings but the risk behind is the cost of this debt financing may outweigh the return that the
company generates on the debt through investment and business activities and become too much for the company to
handle. This can lead to bankruptcy, which would leave shareholders with nothing. In 2008 the short term bank loan
is $1,960,178 and the long term liability is 2,537,831 these is a little increment in the liabilities of this year. By
keeping this view in minds the company decides to reduce its debts and increase its equity through issuing additional
capital in 2009 and 2010. In 2009 the company’s sales decline as compare to 2008. SUZUKI faced tough business
conditions in March 2009, a market slowdown in Europe and North America due to global financial crises. In 2009
Automobile sales have dropped in various parts of the world, however, on account of the world financial crisis, and
they have to face with unprecedented crisis with the prospect of more than 30% fall in expected sales for the next
year compared to previous fiscal year. To overcome this crisis, they have been making. Concerted efforts as a group
with the slogan of
“Try our ingenuity to overcome difficulties.”
As specific measures, facing the fact of a large reduction in sales directly, we promote the establishment of system to
ensure profits in the declining sales by cost reduction. In 2010 the increase in equity is due to increase in the capital
surplus and the retained earnings of the company. Now the company has strengthened its management practices
placing “Let’s Review the current practices and stay true to the basics in order to survive the competition.” As their
basic policy is promoting the growth strategy in this year the company is implementing the previous year strategies
in order to increase in sales. The equity in 2010 is increase due to the issuance of the shares of the company.
Decrease in liabilities due the payment of the short term loans payables and accrued expenses.
HYUNDAI - Debt to Equity Ratio (Amount in 000)
Item 2010 2009 2008 2007 2006
Total Liabilities(A) 71,421,738 62,832,541 61,911,639 64,094,958 53,510,662
Equity (B) 32,255,335 24,804,436 20,160,554 25,275,673 22,553,758
Debt-to-equity
Ratio=A/B(times) 2.20 2.53 3.07 2.53 2.37
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In 2006 the Company and its subsidiaries have entered into lease agreements for certain machinery. The capital lease
obligations are included in long-term debt in the accompanying balance sheets. The company’s mostly loans are
secured. The Company’s and its domestic subsidiaries' property, plant and equipment, certain bank deposits and
investment securities are pledged as collateral for various loans. In 2007 the debt to equity ratio increased as compare
to 2006 due to increase in liabilities and equity. One of our biggest achievements in 2007 was 4.4 percent rise in
production from 2006. The Company entered into derivative instrument contracts including forwards, options and
swaps to hedge the exposure to changes in foreign exchange rate. Accrued warranties also increases in 2007 which
shows that in 2007 company paid more warranties on its increases vehicles. The company uses the options like
forward, future and call options or contracts to enter in the derivative markets for hedging. In the transaction of
currency option and forward company invested in US Dollar and Euro currencies and the company purchased the
shares of KIA Motors. The contract was on the base of difference between fair value and contract initial price. As of
December 31, 2007 and 2006, the Company deferred the net gain of US$30,405 thousand and US$21,390 thousand
respectively, on valuation of the effective portion of derivative instruments for cash flow hedging purposes from
forecasted exports as accumulated other comprehensive income. The year 2007 marked a significant milestone in the
history of this company. Hyundai has completed its second production plant in the China and India with doubling our
production capacity. Hyundai Motor Company expects to continue its growth record in 2008 despite the uncertain
economic climate in the Unites States and the rising cost of oil and raw materials. In 2008 there is a maximum debt
to equity ratio as compare to all years. Despite the difficult economic environment in Korea and abroad, the company
continued to drive the setup of global management structure and improve the quality of their products by putting the
customers first. Hyundai Motor maintained growth in production and sales amidst the global economic crisis
alongside remarkable improvements in quality and technological advancements. In 2008 there is a major increase in
the long term accounts payables and derivative liabilities because the company wants to maintain its present position,
and there is also decrease in the long term accrued but warranties and in the provision for other liabilities. In 2009
the debt to equity ratio decreased from 3.07 to 2.53 because the company is paying attention to increase their equity
and on decreasing their liabilities. This because is due to increase in its ability to pay the debts. They accomplished
great things despite the difficult economic environment both at home and abroad, bringing Hyundai Motor Company
one step closer to becoming a leading global company. The year 2009 was a particularly difficult year for the
automobile market due to the downturn in the global economy. However, despite the adverse conditions, they
managed to attain the highest production and sales recording our history as well as achieving excellent results in
terms of technology, quality and brand equity. In 2009 there is a major decrease in short term borrowings and
derivatives liabilities. This year the company has to face the loss in the derivative market. The equity is increased due
to increase in the capital surplus and retained earnings. In 2010 the minimum debt to equity ratio as compare to the
all previous years. It is a positive sign for the company. In 2010, Hyundai recorded remarkable growth to 3.61
million vehicles sold in the global market; they took over place as a global corporation worthy of the name, 65th
among the top 100 world brands with a brand value of $5 billion.
2.2
2.53
3.07
2.53 2.37
0
0.5
1
1.5
2
2.5
3
3.5
2010 2009 2008 2007 2006
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HONDA - Debt to Equity Ratio (Amount in 000)
Items 2010 2009 2008 2007 2006
Total Liabilities(A) 6,985,622 7,114,243 3,587,066 5,864,449 6,469,067
Equity (B) 1,975,645 2,827,845 3,229,678 2,440,668 2,705,208
Debt-to-equity
Ratio=A/B(times) 3.54 2.52 1.11 2.40 2.39
According to data there is difference between 2006 and 2007 equity. In 2007 company issued the more shares as
compared to 2006. In non-current liabilities there long term finance- secured. In 2006 this long term loan Company
taken from Bank of Tokyo-Mitsubishi Ltd. By mortgaging the assets value 1335 million. The effective mark-up
charged during the year was 9.93%. In 2007 company also took loan as syndicated loan from different banks on
different mark-up rate and paid in different modes of installments. In 2007 there is little bit decrease in liabilities
because in 2007 the company avoid from the short term debt. Its means that in 2007 company paid its debts through
long term loans, company take more long term loans to increase its operations. In 2007 the long term liabilities was
1,958,334 as compared to 672,095 in2006. In 2007 company avoid from the short term borrowing and focus on long
term liabilities and paid almost all debts through long term secured loans so in this way the amount of short term
loans in 2007 remained zero. Due to high long term loans the mark up amount was also high has as compared to
2006. In 2006 and 2007 the mark up accrued on loans and other payables was 15,719 and 39,627 respectively. In
2008 company issued more shares as compared to 2007 and also decreased its long term loans and as well as short
term loans because instead to taking the loans from outside company issued its more shares, through issuing the more
shares the company generated more finance and invested that finance in its new models production and other reason
is that on issuing more shares the company has not the fear to paid the outside loan. In 2008 company increased its
shares capital amount approximately 32.32% as compared to 2007. In 2008 and 2007 amount of long term loans was
500,000 and 1,958,334 respectively. The loan in 2008 has taken from bank of Tokyo- Mitsubishi UFJ, Ltd. The
economic crises also influenced on all sectors and the economic crises can also be the reason of low ratio of long or
short borrowing. If we check the data 2009 and 2010 both years the liabilities increased as compared to equities. The
3.5
2.52
1.11
2.4 2.39
0
0.5
1
1.5
2
2.5
3
3.5
4
2010 2009 2008 2007 2006
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amount of long term secured loans in 2009 and 2008 was 1500,000 and 500,000 respectively. The amount of short
term loans in 2009 was 2,151,601 which was zero in 2008. In 2010 due to the economic crisis the some liabilities
increased like trade and other payables 5,448,222 and 3,387,594 in 2010 and 2009 respectively. Honda also
introduced the hybrid vehicles like Civic, Insight and Accord and in 2006 Insight was the more fuel efficient car of
the year. So due to increase in demand from last few years the company increased its operations and in all plants
company increased its production and to meet the expenses company focus on outside loans instead of issued more
shares because might be possible that very high ratio of issued shares decrease the price of per share.
5. Conclusion
The global economic crisis has created the bad effect on the all automobile industry, as well as SUZUKI, Hyundai
and Honda from 2008-2010. The companies’ sale decreased due to the bad market conditions and also due to the
slum in the overall world economy. As the economic condition become better and due to these companies good
polices the company is now earning the profits by increasing in its sales. The Suzuki overcomes this situation by
keep focusing the research and development department, marketing and most importantly on manufacturing units.
They have also made the strategy about their manufacturing units. The company has manufactured the low units due
to this they have to bear low cost related to their manufacturing. Behind the adoption of this strategy the reason is
that the company has forecasted the expected decline in the sale and due to this they have manufactured low units.
The Hyundai overcome this situation by keep focusing their stakeholders mostly their employees. Because they
consider their customer most important and the company prefer the needs and wants of their customer. And due to
this strategy the crisis has created the low effects on the Hyundai profitability and sales. The Honda after the
recession they began to again paying keen attention on its performance and increased its sales by introducing the
innovation in its different models by launching the hybrid fuel efficient models. With the help competitive
management company overcome its deficiencies which occurred due to recession. The global economic crises have
created the bad effects on these companies but not as much large. All these companies management has the ability to
face and find the solution of it as early as possible (Wad, 2010).
Further because of rapid decrease in financial performance of automobile sector, it was great pressure on the risk
exposure in financial market to control the debt to equity ratio. During crisis companies decided to increase common
stock equity rather than to finance assets through borrowing money. Meanwhile the trend of investment of
automobile sector showed a decline in risky financial instrument. Such a measures on financial positioning is carried
a financial leverage in a better ways. Federal Reserve Bank of USA also took major step to control the wave of
global financial crisis by giving a bailout package to the companies being bankrupt on its financial strength. This
crisis put these companies into market competition in term of technology and product performance. FRB had made
new regulations for such crisis if I does so in future again. It was a lesson for all multinational firm regarding the
financial leverage and management of debt to equity ratio in future.
Over the years the decline that had damaged it somehow came forward with a positive impact after 2010 and this
was because of technological innovation. It was primarily because of the newly found innovations like introduction
of Hybrid Models and Toyota-Prius being a newly introduced product made the wave of constructive destruction for
competitors like Honda, Suzuki and Hyundai. Moreover, the new models with better functions and less production
costs were introduced in the market to further make way for better financial position for these companies in future.
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Chapter
Accounting Principles: What Are They?The Basic Financial StatementsHow Are the Statements Related?Why Bother about the Footnotes?Accounting FlexibilityU.S. Accounting vs. Outside of the U.S.The Bottom LineSolutions to Try It! ProblemsQuestions
Article
We consider a monetary growth model essentially identical to that of Diamond (1965) and Tirole (1985), except that we explicitly model credit markets, a credit market friction, and an allocative function for financial intermediaries. These changes yield substantially different results than those obtained in more standard models. In particular, if any monetary steady state equilibria exist, there are generally two of them; one of these has a low capital stock and output level, and it is necessarily a saddle. The other steady state has a high capital stock and output level; either it is necessarily a sink, or its stability properties depend on the rate of money creation. It follows that monetary equilibria can be indeterminate, and nonconvergence phenomena can be observed. Increases in the rate of money creation reduce the capital stock in the high-capital-stock steady state. If the high-capital-stock steady state is not a sink for all rates of money growth, then increases in the rate of money growth can induce a Hopf bifurcation. Hence dynamical equilibria can display damped oscillation as a steady state equilibrium is approached, and limit cycles can be observed as well. In addition, in the latter case, high enough rates of inflation induce the kinds of "crises" noted by Bruno and Easterly (1995): when inflation is too high there are no equilibrium paths approaching the high-activity steady state.
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