ISBN: 0-03-028931-9

Chapter 5 The Financial Environment: Markets, Institutions, and Interest Rates

Schwab
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Compete in a Changing Environment

Financial managers and investors don't operate in a vacuum – they make decisions within a large and complex financial environment. This environment includes financial markets and institutions, tax and regulatory policies, and the state of the economy. The environment both defines the available financial alternatives and affects the outcomes of various decisions. Therefore, it is crucial that financial managers and investors have a good understanding of the environment in which they operate.
Good financial decisions require an understanding of the current direction of the economy, interest rates, and the stock market – but figuring out what's likely to happen is no trivial matter. Recently, the financial environment has been extraordinarily favorable to financial managers and investors: The economy has not seen a recession for nearly ten years; interest rates and inflation have remained relatively low; and the stock market has boomed throughout most of the past decade. At the same time, the financial environment has undergone tremendous changes, presenting financial managers and investors with both opportunities and risks.
Consider Charles Schwab and Merrill Lynch. Benefiting from the strong stock market, traditional brokerage powerhouse Merrill Lynch has seen its stock rise more than 250 percent over the past five years. During this same period, Charles Schwab, the leader in online trading, has seen its stock rise by nearly 1,800 percent! The Internet has enabled online brokers such as Schwab, E*Trade, DLJDirect, and Datek to offer investors the opportunity to trade stocks at a small fraction of the price traditionally charged by full-service firms such as Merrill Lynch. While online trading was virtually nonexistent just a couple of years ago, there are now an estimated 100 online brokers serving more than 4 million customers. Some estimate that by 2003 there will be more than 20 million online accounts.
Schwab's and Merrill Lynch's recent stock market performances indicate that the market is increasingly concerned about online trading's effect on full-service brokers. Despite a recent 30 percent pullback in its stock price, Schwab's stock has risen more than 260 percent over the past two years. During this same period, Merrill Lynch's stock price has actually declined. Recognizing this changing environment, Merrill Lynch has taken a few tentative steps toward offering its customers the opportunity to trade online.
The same forces that dramatically affected the brokerage industry have had similar effects on other industries. Companies such as Barnes and Noble and Toys α Us have been presented with new and aggressive competition from the likes of Amazon.com and eToys Inc. Likewise, changing technology has altered the way millions of consumers purchase airline tickets, hotel rooms, and automobiles. Consequently, financial managers must understand today's technological environment and be ready to change operations as the environment evolves.

DISCUSSION QUESTIONS

1. In your opinion, what are the major concerns with online investing? Do you currently have an online brokerage account or are favorable to starting an account? If not, what factors present the greatest deterrence to online investing for you?
2. What concerns do you have, if any, about online retailing? Do you actively purchase products online? If not, why not?

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