Chapter 2 COMPONENTS OF FINANCIAL MARKET SYSTEM. Financial Markets Primary Market Second Market...

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Transcript of Chapter 2 COMPONENTS OF FINANCIAL MARKET SYSTEM. Financial Markets Primary Market Second Market...

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Chapter 2 COMPONENTS OF FINANCIAL MARKET SYSTEM Slide 2 Financial Markets Primary Market Second Market Money Market Capital Market Organized Securities Exchanges Over-the-Counter Markets Public Offerings and Private Placement Slide 3 Organized Securities Exchanges (1) New York Stock Exchange, (NYSE) (2) American Stock Exchange, (AMEX) (3) Mid-west Stock Exchange, (4) Pacific Stock Exchange, (5) Philadelphia Stock Exchange, (6) Boston Stock Exchange, and Slide 4 New York Stock Exchange (NYSE) Membership seat 1366 seats since 1953. Seat fee: $760,000 to a high of $830,000.' 1995 auction :make a market matching pricing (asked and offered) Price Quotes 82% Slide 5 Function of the NYSE 1Providing a continuous market. 2. Establishing and publicizing fair security prices. 3. Helping business raise new capital. Slide 6 Listing Requirements (1) profitability (2) size (3) market value (4) public ownership. Slide 7 Profitability EBT: at 1east $2.5 million. For the two years preceding EBT:at least $2.0 million. Size Net tangible assets: at least $18.0 million. Slide 8 Market Value The market value: at least $18.0 million. Public Ownership common shares :1.1 million publicly held holders of 100 shares :at least 2,000. Slide 9 THE INVESTMENT BANKER a financial specialist involved as an intermediary in the merchandising of securities. Banking Act of 1933(also known as the Glass-Steagall Act of 1933). Slide 10 Functions of Institutes (1) underwriting, (2) distributing, (3) advising. Slide 11 Distribution Methods Most competitive bid purchases (1) rail-road issues, (2) public utility issues, (3) state and municipal bond issues. (4) Commission or Lest-Efforts Basis (5) Privileged Subscription (6) Direct Sale Slide 12 (1) current stockholders, (2) employees, or (3) customers. Slide 13 PRIVATE PLACEMENTS (1) life insurance companies, (2) state and local retirement funds, (3) private pension funds. Slide 14 Advantages of private placement 1. Speed. 2. Reduced flotation costs. 3. Financing flexibility. Slide 15 disadvantages 1. Interest costs. 2. Restrictive covenants. 3. The possibility of future SEC registration. Slide 16 Leading U.S. Investment Bankers, 1995 (Domestic debt and Equity issue) (BILLION OF DOLLARS FIRM UNDERWRITING VOLUME Percent 1 Merrill Lynch 122.3 17.9% 2 Lehman Brothers 70.3 9.9 3 Golden Sachs 68.5 9.7 3 Morgan Stanley 68.5 9.7 5 Salomon Brother 68.1 9.6 6 CS First Boston 64.6 9.1 7 J.R. Morgan 40.2 5.7 8 Bear, Sterns 25.4 3.6 Donaldson Lufkin & Jenrette 22.2 3.1 10 Smith Barney 20.7 2.9 Slide 17 Table 2-6 Public and Privately Placed Corporate Debt Placed Domestically (Gross proceeds of All New U.S. Corporate Debt Issue) Total Volume Percent Publicly Percent Privately Year (S Millions) Placed (%) Placed (%) 1994 $441287 82 8 17 2 1993 361860 79 3 20 7 1992 443911 85 2 14 8 1991 603119 80 7 19 3 1990 276259 68 5 31 5 1989 298813 60 7 39 3 1988 329919 61 3 38 7 1987 301447 69 5 30 5 1986 313502 74 2 25 8 1985 165754 72 1 27 9 1984 109903 66 9 33 1 Slide 18 FLOTATION COSTS (1) the underwriters spread (2) issuing costs. (a) printing and engraving, (b) legal fees, (3) accounting fees, (4) trustee fees, several other miscellaneous components. Slide 19 REGULATION 1929--1932, State statutes (blue sky laws) Securities Acts Amendments of 1975 Primary Market Regulations 1982 Slide 20 25 investors not be registered 1. less than $1.5 billion of new securities per year. 2. Issues that are sold entirely intrastate. 3. short-term instruments: maturity periods of 270 days or less. 4. Issues that are already regulated or controlled by some other federal agency Slide 21 Mr. Ivan F. Boesky, a loophole in the 1940 Ponzis Scheme Enron and WorldCom Slide 22 Slide 23 Slide 24 Slide 25 Primary market regulation Full public disclosure Firm file a registration statement with the SEC a minimum 20-day waiting period, registration process a preliminary prospectus (the red herring ) Slide 26 Secondary Market Regulations Shelf Registration 1. Major security exchanges must register with the SEC. 2. Insider trading is regulated. 3. Manipulative trading 4. The SEC is given control over proxy procedures. 5. The Board of Governors of the Federal Reserve System Slide 27 Figure 2-4 Average Annual Returns and Standard Deviations of Returns, 1926-1995 Slide 28 Figure 2-5 Rates of Return and Standard Deviations, 1926-1995 Slide 29 Table 2-7 Interest Rate Level and Inflation Rates 1981-1995 3-Month 30-Year A AA Rated Inflation Treasury Bills Treasury Bonds Corporate Bonds rate 1981 14.08 13.44 14.17 8.9 1982 10.69 12.76 13.79 3.9 1983 8.63 11.18 12.04 3.8 1984 9.52 12.39 12.71 4.0 1985 7.49 10.79 11.37 3.8 1986 5.98 7.80 9.02 1.1 1987 5.82 8.58 9.38 4.4 1988 6.68 8.96 9.71 4.4 1989 8.12 8.45 9.26 4.6 1990 7.51 8.61 9.32 6.1 1991 5.42 8.14 8.77 3.1 1992 3.45 7.67 8.14 2.9 1993 3.02 6.59 7.22 2.7 1994 4.29 7.37 7.97 2.7 1995 5.51 6.88 7.59 2.5 Mean 7.08 9.31 10.03 3.93 Slide 30 Slide 31 INTEREST RATE and DETERMINANTS k = k* + IRP + DRP + MP + LP k = the nominal or observed rate k* = the real risk--free rate of interest, IRP = inflation-risk premium. DRP = default-risk premium MP = maturity LP = liquidity premium Slide 32 Nominal Interest rate k = k* + IRP + DRP + MP + LP k = ? k* = 3.1%, IRP = 1.5% DRP = 0.05% MP = 0.02% LP = 0.05% K = 3.1% + 1.5% +0.05% + 0.02%+ 0.05% = 4.72% Slide 33 In reality 2.75% - 4.72% = - 1.97% ??? Housing ?? Medical care?? Education?? Electricity?? Special interest group. Slide 34 K rf = k* + IRP (2-2) Slide 35 The Effects of Inflation on Rates of Return and the Fisher Effect K rf =k *+ IRP + (k*. IRP) 0.113 = k* +.05 + '05k* K* =.06 = 6% Slide 36 MEAN MEAN INFERRED NOMINAL YIELD INFLATION RATE REAL RATE SECURITY % % % Treasury bills 7.08 3.93 3.15 Treasury bonds 9.31 3.93 5.38 Corporate bonds 10.03 3.93 6.10 Slide 37 THE TERM STRUCTURE OF INTEREST RATES Slide 38 Historical Interest Rates 21030 9 13 1 Years to maturity Int er est rat e Oct 31, 19 79 Mar 31, 19 90 Nov 13, 19 91 Slide 39 Explaining Term Structure (1) the unbiased expectations theory, (2) the liquidity preference theory, (3) the market segmentation theory. Slide 40 SUMMARY market environment structure of financial markets the institution of investment banking various methods for distributing securities role of interest rates Slide 41 Components of financial market public offerings private placements institutional investors. financial instruments The secondary market money and capital markets primary and secondary organized security exchanges over-the-counter market Slide 42 Investment banker functions of (l) underwriting, (2) distributing, and (3) advising. the negotiated purchase, (2) the competitive bid purchase, (3) the commission or best- efforts basis, (4) privileged subscriptions, and (5) direct sales. Slide 43 Private placements (l) life insurance firms, (2) state and local retirement funds, and (3) private pension funds. advantages and disadvantages Slide 44 Flotation costs securities Act Of l933. Rates of return