Ch,14 - Rising Capital in
The Financial Markets
? 2002,Prentice Hall,Inc,
Q,What are SECURITIES?
A,Financial Assets that
Investors purchase hoping to
earn a high rate of return,
Types of Securities
? Treasury Bills and Treasury Bonds
? Municipal Bonds
? Corporate Bonds
? Preferred Stocks
? Common Stocks
Which of these are RISKY?
Which promise HIGH RETURNS?
Is there a relationship between RISK
and RETURN?
Corporate Financing
Sources
? In 1999,over $400 billion in external
corporate financing was raised,
? From 1996 through 1999,capital has been
raised through the following sources,
? Corporate Bonds and Notes 75.3%
? Equities 24.7%
Movement of Savings
? Direct Transfer of Funds
Movement of Savings
? Direct Transfer of Funds
saver
Movement of Savings
? Direct Transfer of Funds
saver firm
Movement of Savings
? Direct Transfer of Funds
cash
saver firm
Movement of Savings
? Direct Transfer of Funds
cash
securities
saver firm
Movement of Savings
? Indirect Transfer using Investment Banker
Movement of Savings
? Indirect Transfer using Investment Banker
investment
banker
Movement of Savings
? Indirect Transfer using Investment Banker
investment
banker firm
Movement of Savings
? Indirect Transfer using Investment Banker
funds
investment
banker firm
Movement of Savings
? Indirect Transfer using Investment Banker
funds
securities
investment
banker firm
Movement of Savings
? Indirect Transfer using Investment Banker
funds
securities
saver
investment
banker firm
Movement of Savings
? Indirect Transfer using Investment Banker
funds funds
securities
saver
investment
banker firm
Movement of Savings
? Indirect Transfer using Investment Banker
securities
funds funds
securities
saver
investment
banker firm
Movement of Savings
? Indirect Transfer using a Financial Intermediary
Movement of Savings
? Indirect Transfer using a Financial Intermediary
financial
intermediary
Movement of Savings
? Indirect Transfer using a Financial Intermediary
financial
intermediary firm
Movement of Savings
? Indirect Transfer using a Financial Intermediary
funds
financial
intermediary firm
Movement of Savings
? Indirect Transfer using a Financial Intermediary
funds
firm securities
financial
intermediary firm
Movement of Savings
? Indirect Transfer using a Financial Intermediary
funds
firm securities
financial
intermediary firm saver
Movement of Savings
? Indirect Transfer using a Financial Intermediary
funds funds
firm securities
financial
intermediary firm saver
Movement of Savings
? Indirect Transfer using a Financial Intermediary
funds
intermediary securities
funds
firm securities
financial
intermediary firm saver
Financial Market Components
? Public Offering
Financial Market Components
? Public Offering
– Firm issues securities,which are
made available to both individual
and institutional investors,
Financial Market Components
? Public Offering
– Firm issues securities,which are
made available to both individual
and institutional investors,
? Private Placement
Financial Market Components
? Public Offering
– Firm issues securities,which are
made available to both individual
and institutional investors,
? Private Placement
– Securities are offered and sold to a
limited number of investors,
Financial Market Components
? Primary Market
Financial Market Components
? Primary Market
– Market in which new issues of a
security are sold to initial buyers,
Financial Market Components
? Primary Market
– Market in which new issues of a
security are sold to initial buyers,
? Secondary Market
Financial Market Components
? Primary Market
– Market in which new issues of a
security are sold to initial buyers,
? Secondary Market
– Market in which previously issued
securities are traded,
Financial Market Components
? Money Market
Financial Market Components
? Money Market
– Market for short-term debt
instruments (maturity periods of
one year or less),
Financial Market Components
? Money Market
– Market for short-term debt
instruments (maturity periods of
one year or less),
? Capital Market
Financial Market Components
? Money Market
– Market for short-term debt
instruments (maturity periods of
one year or less),
? Capital Market
– Market for long-term securities
(maturity greater than one year),
Financial Market Components
? Organized Exchanges
Financial Market Components
? Organized Exchanges
– Buyers and sellers meet in one central
location to conduct trades,
Financial Market Components
? Organized Exchanges
– Buyers and sellers meet in one central
location to conduct trades,
? Over-the-Counter (OTC)
Financial Market Components
? Organized Exchanges
– Buyers and sellers meet in one central
location to conduct trades,
? Over-the-Counter (OTC)
– Securities dealers operate at many
different locations across the country,
Financial Market Components
? Organized Exchanges
– Buyers and sellers meet in one central
location to conduct trades,
? Over-the-Counter (OTC)
– Securities dealers operate at many
different locations across the country,
– Connected by Nasdaq system (National
Association of Securities Dealers
Automated Quotation system),
Investment Banking
How do investment bankers help
firms issue securities?
Underwriting the issue,
Distributing the issue,
Advising the firm,
Distribution Methods
? Negotiated Purchase
Distribution Methods
? Negotiated Purchase
– Issuing firm selects an investment
banker to underwrite the issue,
Distribution Methods
? Negotiated Purchase
– Issuing firm selects an investment
banker to underwrite the issue,
– The firm and the investment banker
negotiate the terms of the offer,
Distribution Methods
? Negotiated Purchase
– Issuing firm selects an investment
banker to underwrite the issue,
– The firm and the investment banker
negotiate the terms of the offer,
? Competitive Bid
Distribution Methods
? Negotiated Purchase
– Issuing firm selects an investment
banker to underwrite the issue,
– The firm and the investment banker
negotiate the terms of the offer,
? Competitive Bid
– Several investment bankers bid for the
right to underwrite the firm’s issue,
Distribution Methods
? Negotiated Purchase
– Issuing firm selects an investment
banker to underwrite the issue,
– The firm and the investment banker
negotiate the terms of the offer,
? Competitive Bid
– Several investment bankers bid for the
right to underwrite the firm’s issue,
– The firm selects the banker offering
the highest price,
Distribution Methods
? Best Efforts
Distribution Methods
? Best Efforts
– Issue is not underwritten,
Distribution Methods
? Best Efforts
– Issue is not underwritten,
– Investment bank attempts to sell the
issue for a commission,
Distribution Methods
? Best Efforts
– Issue is not underwritten,
– Investment bank attempts to sell the
issue for a commission,
? Privileged Subscription
Distribution Methods
? Best Efforts
– Issue is not underwritten,
– Investment bank attempts to sell the
issue for a commission,
? Privileged Subscription
– Investment banker helps market the
new issue to a select group of investors,
Distribution Methods
? Best Efforts
– Issue is not underwritten,
– Investment bank attempts to sell the
issue for a commission,
? Privileged Subscription
– Investment banker helps market the
new issue to a select group of investors,
– Usually targeted to current
stockholders,employees,or customers,
Distribution Methods
? Direct Sale
Distribution Methods
? Direct Sale
– Issuing firm sells the securities directly
to the investing public,
Distribution Methods
? Direct Sale
– Issuing firm sells the securities directly
to the investing public,
– No investment banker is involved,
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? What type of issue is this?
? It’s a negotiated purchase,
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? How many shares will be sold?
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? How many shares will be sold?
? $100,000,000 / $20 = 5 million new
shares of common stock,
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? What are the flotation costs?
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? What are the flotation costs?
? Underwriting spread,2% of $100
million = $2 million,
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? What are the flotation costs?
? Underwriting spread,2% of $100
million = $2 million,
? Issuing costs,printing and engraving
costs; legal,accounting and trustee fees,
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? What are the risks?
Stock Issue Example,
Our firm needs to raise approximately
$100 million for expansion,Our stock
price is $20,We Select Merrill Lynch to
underwrite the issue for a 2%
underwriting spread,
? What are the risks?
? The investment bank accepts the risk of
being able to sell the new stock issue for
$20 per share,If the stock price falls,
the investment bank could lose money,
Regulations,
The Primary Market
The Securities Act of 1933
? Firms register with the Securities
Exchange Commission (SEC),
? SEC has 20 days to review,
Regulations,
The Primary Market
The Securities Act of 1933
? Firms register with the Securities
Exchange Commission (SEC),
? SEC has 20 days to review,
–SEC may ask for more information,
Regulations,
The Primary Market
The Securities Act of 1933
? Firms register with the Securities
Exchange Commission (SEC),
? SEC has 20 days to review,
–SEC may ask for more information,
–The firm cannot solicit buyers during
the review period but can advertise,
Regulations,
The Secondary Market
The Securities Exchange Act of 1934
? Established the SEC,
? Exchanges must register with SEC,
? Company information must be
available to the public,
? Insider trading is regulated,
Regulations,
Recent Developments
Securities Acts Amendments of 1975
? Created National Market System,
? Eliminated fixed brokerage
commissions,
SEC Rule 415
? Allows Shelf Registration