Definition
Corporate Finance
In corporate finance, a ‘pool’ refers to the concept that investment projects are financed out of a pool of funds rather than being financed separately through bonds, preferred stock, and common stock. This allows for the use of a weighted average cost of capital (WACC) when evaluating the return on investment projects.
Industry
In an industrial or commercial context, ‘pooling’ refers to the joining of companies to improve profits by reducing competition. However, such poolings are generally outlawed in the United States by various antitrust laws aimed at preserving market competition.
Insurance
In the insurance sector, a ‘pool’ is an association of insurers who share premiums and losses to spread risk. This practice allows smaller insurers to compete with larger ones by distributing the risk of claims across multiple entities.
Investments
In the realm of investments, the term ‘pool’ can have two main meanings:
- Combination of resources for a common purpose or benefit.
- Group of investors joining together to use their combined financial power to manipulate security or commodity prices or to obtain control of a corporation. Such manipulative pools are outlawed by regulations governing securities and commodities trading.
Real Estate
In real estate, a ‘pool’ typically refers to a group of mortgages that are used as collateral for a pass-through security. This practice helps to securitize real estate loans, making them less risky and more attractive to investors.
Examples
-
Corporate Finance: A company using a mix of internal funds, bonds, stock, and loans to fund a new project reflects the pooling of resources, which allows calculation based on the weighted average cost of capital.
-
Industry: Two large oil companies might attempt to pool their resources to dominate the market; however, such attempts could be challenged under antitrust laws.
-
Insurance: Smaller insurance companies join a risk pool to collectively manage catastrophic event risks like floods or earthquakes, allowing each to offer such protections without bearing the entire burden individually.
-
Investments: A syndicate of investors pooling funds to influence the stock price of a corporation would be considered illegal under most securities regulations.
-
Real Estate: A collection of residential mortgages bundled together and sold as a Mortgage-Backed Security (MBS) reflects a real estate pool used for creating pass-through securities.
Frequently Asked Questions
What is the purpose of using a pool in corporate finance?
In corporate finance, using a pool allows a company to finance multiple projects more efficiently by using a blended cost of capital from various sources, like debt and equity.
Why are pooling arrangements generally outlawed in the industry?
Pooling arrangements in industries often reduce competition and can lead to monopolistic behavior, which is why they are generally outlawed by antitrust laws to promote fair competition.
How do insurance pools benefit smaller insurers?
Insurance pools help smaller insurers by enabling them to share risk with other insurers, thus allowing them to offer coverage for large or unpredictable risks that they would not be able to manage alone.
Are investment pools legal?
While investment pools for the purpose of collective benefit or resource sharing are legal, pools that aim to manipulate market prices or obtain control of corporations are illegal under securities and commodities trading regulations.
How does pooling work in the real estate industry?
In real estate, pooling involves bundling several mortgages together to create mortgage-backed securities, providing diversification of risk and liquidity for investors.
Related Terms
Cost of Capital
The cost of capital is the required return necessary to make a capital budgeting project, such as building a new factory, worthwhile. It includes the costs of debt and equity financing.
Antitrust Laws
Antitrust laws are designed to prevent monopolies and promote competition within markets. They restrict the ability for firms to engage in anti-competitive practices.
Pass-Through Security
A pass-through security is a Pool of fixed-income securities backed by a package of assets. It is structured such that both interest and principal payments pass from the borrower through an intermediary to the investor.
Blind Pool
A blind pool is typically a limited partnership or another form of investment vehicle that does not specify how investors’ money will be invested.
Online Resources
- Investopedia
- U.S. Securities and Exchange Commission (SEC)
- NAIC — National Association of Insurance Commissioners
- Federal Trade Commission — Antitrust Laws
Suggested Books for Further Studies
- “Corporate Finance: A Focused Approach” by Michael C. Ehrhardt and Eugene F. Brigham
- “Antitrust Law, Policy, and Procedure: Cases, Materials, Problems” by E. Thomas Sullivan and H. Hovenkamp
- “Principles of Risk Management and Insurance” by George E. Rejda and Michael J. McNamara
- “Real Estate Finance & Investments” by William B. Brueggeman and Jeffrey D. Fisher
- “Options, Futures, and Other Derivatives” by John C. Hull
Fundamentals of Pool: Corporate Finance Basics Quiz
Thank you for exploring with us the diverse applications of ‘pool’ across various fields like corporate finance, industry, insurance, investments, and real estate. We encourage further learning and understanding to excel in these topics!
