Ch. 14 - Rising Capital in The Financial Markets 2002, Prentice Hall, Inc.

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 FinancingSources

• 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


saver

Movement of Savings


saverfirm

Movement of Savings


cashcash

saverfirm

Movement of Savings


cashcash

securitiessecurities

saverfirm

Movement of Savings

• Indirect Transfer using Investment Banker

Movement of Savings


investmentbanker

Movement of Savings


investmentbanker firm

Movement of Savings


fundsfunds


Movement of Savings


fundsfunds


saver


Movement of Savings


fundsfundsfundsfunds


saver


Movement of Savings



fundsfundsfundsfunds


saver


Movement of Savings• Indirect Transfer using a Financial Intermediary


financialintermediary


financialintermediary firm


fundsfunds



fundsfunds

firmfirmsecuritiessecurities



fundsfunds



saver


fundsfunds fundsfunds



saver


fundsfunds

intermediaryintermediarysecuritiessecurities

fundsfunds



saver

Financial Market Components

• Public Offering


• Public Offering– Firm issues securities, which are

made available to both individual and institutional investors.




• Private Placement




• Private Placement– Securities are offered and sold to a

limited number of investors.


• Primary Market


• Primary Market–Market in which new issues of a

security are sold to initial buyers.




• Secondary Market




• Secondary Market–Market in which previously issued

securities are traded.


• Money Market


• Money Market–Market for short-term debt

instruments (maturity periods of one year or less).




• Capital Market




• Capital Market–Market for long-term securities

(maturity greater than one year).


• Organized Exchanges


• Organized Exchanges– Buyers and sellers meet in one central

location to conduct trades.




• Over-the-Counter (OTC)




• Over-the-Counter (OTC)– Securities dealers operate at many

different locations across the country.




• 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



– Issuing firm selects an investment banker to underwrite the issue.




– The firm and the investment banker negotiate the terms of the offer.





• Competitive Bid





• Competitive Bid

– Several investment bankers bid for the right to underwrite the firm’s issue.





• Competitive Bid

– Several investment bankers bid for the right to underwrite the firm’s issue.

– The firm selects the banker offering the highest price.


• Best Efforts


• Best Efforts

– Issue is not underwritten.


• Best Efforts


– Investment bank attempts to sell the issue for a commission.


• Best Efforts



• Privileged Subscription


• Best Efforts




– Investment banker helps market the new issue to a select group of investors.


• Best Efforts




– Investment banker helps market the new issue to a select group of investors.

–Usually targeted to current stockholders, employees, or customers.


• Direct Sale


• Direct Sale

– Issuing firm sells the securities directly to the investing public.


• 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.


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?



• How many shares will be sold?

• $100,000,000 / $20 = 5 million new shares of common stock.



• What are the flotation costs?




• Underwriting spread: 2% of $100 million = $2 million.




• Underwriting spread: 2% of $100 million = $2 million.

• Issuing costs: printing and engraving costs; legal, accounting and trustee fees.



• What are the risks?



• 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.




• SEC has 20 days to review.–SEC may ask for more information.




• 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

Ch. 14 - Rising Capital in The Financial Markets 2002, Prentice Hall, Inc.

Documents

Transcript of Ch. 14 - Rising Capital in The Financial Markets 2002, Prentice Hall, Inc.